Binary Choice Models with Social Interactions under Heterogeneous Rational Expectations

This paper extends Brock and Durlauf’s models on binary choice with social interactions. In the extended model, an individual will form expected behaviors of peers taking into account their characteristics. The expected behaviors of peers in a group are heterogeneous. The expectations of peers are determined as rational expectations. We consider models in both group and network settings. Endogenous interaction, contextual and correlated effects are identifiable. Conditions under which an unique equilibrium exits are presented. In the group setting, multiple equilibria can be characterized by an aggregate scalar index. As an empirical application, an adolescent’s smoking behavior is studied. The results show there exists significant endogenous peer effect, and many contextual variables are significant in influencing an adolescent’s smoking behavior. JEL classification: C21, C25, I10, J13