Simulation-based estimation of peer effects

The influence of peer behavior on an individual's choices has received renewed interest in recent years. However, accurate measures of this influence are difficult to obtain. Standard reduced-form methods lead to upwardly biased estimates due to simultaneity, common shocks, and nonrandom peer group selection. This paper describes a structural econometric model of peer effects in binary choice, as well as a simulated maximum likelihood estimator for its parameters. The model is nonparametrically identified under plausible restrictions, and can place informative bounds on parameter values under much weaker restrictions. Monte Carlo results indicate that this estimator performs better than a reduced form approach in a wide variety of settings. A brief application to youth smoking demonstrates the method and suggests that previous studies dramatically overstate peer influence. (c) 2005 Elsevier B.V. All rights reserved.