Two-step estimation of endogenous and exogenous group effects

In this article, we propose a two-step method to identify and estimate endogenous and exogenous social interactions in the Manski (1993) and Brock and Durlauf's (2001a,b) discrete choice model with unobserved group variables. Taking advantage of social groups with large group sizes, we first estimate a probit model with group fixed-effects, and then use the instrumental variables method to estimate endogenous and exogenous group effects via the group fixed-effect estimates. Our method is computationally simple. The method is applicable not only to the case of single equilibrium but also the multiple equilibria case without the need to specify an (arbitrary) equilibrium selection mechanism. The article provides a Monte Carlo study on the finite sample performance of such estimators.