Estimating Demand in Search Markets: The Case of Online Hotel Bookings

In this paper, we emphasize that choice sets generated by a search process have two properties: first, they are limited; second, they are endogenous to preferences. Both factors lead to biased estimates in a static demand framework that takes choice sets as given. To correct for this bias, we estimate a structural model of search for differentiated products, using a unique dataset of consumer online search for hotels. Within a nested logit utility model, we show that the mean utility function and the search cost distribution of a representative consumer are non-parametrically identified, given our data. Using our model’s estimates, we quantify both sources of bias: they lead to overestimation of price elasticity by a factor of five and four, respectively. The median search cost is about 38 dollars per 15 hotels; we also present some evidence on multi-modality of search cost distribution. JEL Classifications: C14, D43, D83, L13 Sergei Koulayev is an economist in the Consumer Payments Research Center of the Federal Reserve Bank of Boston. His e-mail address is [email protected]. This paper, which may be revised, is available on the web site of the Federal Reserve Bank of Boston at http://www.bos.frb.org/economic/wp/index.htm. This paper is part of my dissertation at Columbia University. I am indebted to my advisors, Michael Riordan, Bernard Salanié, and Kate Ho for their continual advice and encouragement. I am grateful to participants in the Applied Micro Theory colloquium, the Industrial Organization colloquium, and the Friday talks, all at Columbia University, for their helpful suggestions. Special thanks to Ting Wu for his support at early stages of this research. Financial support from the Program of Economic Research at Columbia University, from the NET Institute (www.netinst.org), and from the Kauffman Foundation is gratefully acknowledged. The views and opinions expressed in this paper are those of the author and do not necessarily represent the views of the Federal Reserve Bank of Boston or the Federal Reserve System. This version: December 14, 2009