PanelDataNotes 23

Part 23: Parameter Heterogeneity [1/115]
Econometric Analysis of Panel Data
William Greene
Department of Economics
Stern School of Business
Econometric Analysis of Panel Data
23. Individual Heterogeneity

and Random Parameter Variation
Heterogeneity
Observational: Observable differences across

individuals (e.g., choice makers)
Choice strategy: How consumers make

decisions the underlying behavior
Structural: Differences in model frameworks

Preferences: Differences in model parameters
Parameter Heterogeneity
(1) Regression model

y i,t x i,t i it
(2) Conditional probability or other nonlinear model
f(y it | x i,t , i )
(3) Heterogeneity - how are parameters distributed across
individuals?
(a) Discrete - the population contains a mixture of Q
types of individuals.
(b) Continuous. Parameters are part of the stochastic
structure of the population.
Distinguish Bayes and Classical

Both depart from the heterogeneous model,
f(yit|xit)=g(yit,xit,i)
What do we mean by randomness
With respect to the information of the analyst (Bayesian)
With respect to some stochastic process governing nature
(Classical)
Bayesian: No difference between fixed and random
Classical: Full specification of joint distributions for
observed random variables; piecemeal definitions of
random parameters. Usually a form of random
effects
Fixed Management and Technical Efficiency

in a Random Coefficients Model
Antonio Alvarez, University of Oviedo

Carlos Arias, University of Leon
William Greene, Stern School of Business, New York University
The Production Function Model

Definition: Maximal output, given the inputs
Inputs: Variable factors, Quasi-fixed (land)
Form: Log-quadratic - translog
Latent Management as an unobservable input
1
ln yit = x ln xit xx (ln xit )2
2
1
m mi mm mi2 xm ln xit mi vit
2
Application to Spanish Dairy Farms
N = 247 farms, T = 6 years (1993-1998)
Input Units Mean Std. Dev. Minimum Maximum
Milk Milk production (liters) 131,108 92,539 14,110 727,281
Cows # of milking cows 2.12 11.27 4.5 82.3
Labor # man-equivalent units 1.67 0.55 1.0 4.0
Land Hectares of land devoted 12.99 6.17 2.0 45.1

to pasture and crops.
Feed Total amount of feedstuffs 57,941 47,981 3,924.14 376,732

fed to dairy cows (tons)
Translog Production Model

ln yit = ln yit* - uit
k 1 k ln xitk
K K K
1
2 k 1 l 1
kl ln xitk ln xitl
m
K
+ m m *
i
1
2 mm
*2
i
1
2
k 1 km
ln x m*
itk i
+ vit - uit
mi * is an unobserved, time invariant effect.
uit = ln yit* - ln yit

m 1 2 k 1 km ln xkit
K
m *
i mi 1 2 mm mi* 2 mi2 0.
Random Coefficients Model
ln yit m m 2 mm m k 1 k 2 km i itk
K
*
i
1 *2
i 1 m* ln x

K K
1
2 k 1 l 1
kl ln xitk ln xitl vit uit

K K K
i k 1 ki ln xitk 1
2 k 1 l 1
kl ln xitk ln xitl it
K
mi* k ln xk wi
k 1
[Chamberlain/Mundlak:]
(1) Same random effect appears in each random parameter
(2) Only the first order terms are random
Discrete vs. Continuous Variation

Classical context: Description of how parameters are distributed
across individuals
Variation
Discrete: Finite number of different parameter vectors distributed
across individuals
Mixture is unknown as well as the parameters: Implies randomness from
the point of the analyst. (Bayesian?)
Might also be viewed as discrete approximation to a continuous
distribution
Continuous: There exists a stochastic process governing the
distribution of parameters, drawn from a continuous pool of
candidates.
Background common assumption: An over-reaching stochastic
process that assigns parameters to individuals
Discrete Parameter Variation
The Latent Class Model

(1) Population is a (finite) mixture of Q types of individuals.
q = 1,...,Q. Q 'classes' differentiated by (q )
(a) Analyst does not know class memberships. ('latent.')
(b) 'Mixing probabilities' (from the point of view of the
J
analyst) are 1 ,..., Q , with q=1 q 1
(2) Conditional density is
P(y i,t | class q) f(y it | x i,t , q )
Latent Classes
A population contains a mixture of individuals of
different types (classes)
Common form of the data generating mechanism
within the classes
Observed outcome y is governed by the
common process F(y|x,j )
Classes are distinguished by the parameters, j.
How Finite Mixture Models Work

Find the Best Fitting Mixture of Two Normal Densities
2 1 yi - j
LogL = i=1 log j=1 j
1000

j j
Maximum Likelihood Estimates
Class 1 Class 2
Estimate Std. Error Estimate Std. error
7.05737 .77151 3.25966 .09824
3.79628 .25395 1.81941 .10858
.28547 .05953 .71453 .05953
F(y) = .28547 1 y - 7.05737 1 y - 3.25966

3.79628 3.79628 +.71453 1.81941 1.81941

Mixing probabilities .715 and .285

Approximation
Actual
Distribution
Application Shoe Brand Choice

Simulated Data: Stated Choice, 400 respondents, 8 choice
situations
3 choice/attributes + NONE
Fashion = High=1 / Low=0
Quality = High=1 / Low=0
Price = 25/50/75,100,125 coded 1,2,3,4,5 then divided by 25.
Heterogeneity: Sex, Age (<25, 25-39, 40+) categorical

Underlying data generated by a 3 class latent class process (100,
200, 100 in classes)
Thanks to www.statisticalinnovations.com (Latent Gold)
A Random Utility Model

Random Utility Model for Discrete Choice
Among J alternatives at time t by person i.
Uitj = j + xitj + ijt
j = Choice specific constant
xitj = Attributes of choice presented to person
(Information processing strategy. Not all
attributes will be evaluated. E.g., lexicographic
utility functions over certain attributes.)
= Taste weights, Part worths, marginal utilities
ijt = Unobserved random component of utility

Mean=E[ ijt] = 0; Variance=Var[ ijt] = 2
The Multinomial Logit Model

Independent type 1 extreme value (Gumbel):
F(itj) = 1 Exp(-Exp(itj))
Independence across utility functions
Identical variances, 2 = 2/6
Same taste parameters for all individuals
exp( j +'xitj )
Prob[choice j | i,t] =

J(i,t)
j=1
exp( j +'xitj )
Estimated MNL
+---------------------------------------------+
| Discrete choice (multinomial logit) model |
| Log likelihood function -4158.503 |
| Akaike IC= 8325.006 Bayes IC= 8349.289 |
| R2=1-LogL/LogL* Log-L fncn R-sqrd RsqAdj |
| Constants only -4391.1804 .05299 .05259 |
+---------------------------------------------+
+---------+--------------+----------------+--------+---------+
|Variable | Coefficient | Standard Error |b/St.Er.|P[|Z|>z] |
+---------+--------------+----------------+--------+---------+
BF 1.47890473 .06776814 21.823 .0000
BQ 1.01372755 .06444532 15.730 .0000
BP -11.8023376 .80406103 -14.678 .0000
BN .03679254 .07176387 .513 .6082
Latent Classes and Random Parameters

Heterogeneity with respect to 'latent' consumer classes
Pr(Choicei ) = q=1 Pr(choicei | class = q)Pr(class = q)
Q
exp(xi,choiceclass )
Pr(choicei | class = q) =
j=choice exp(xi,jclass )
exp(zi q )
Pr(class = q | i) = i,q , e.g., Fi,q =
q=classes exp(zi q )
Simple discrete random parameter variation
exp(xi,choicei )
Pr(choicei | i ) =
j=choice exp(xi,ji )
exp(zi q )
Pr (i q ) i,q = , q = 1,..., Q
q=classes exp(zi q )
Pr(Choicei ) = q=1 Pr(choice | i q )Pr(q )
Q
+---------------------------------------------+
| Latent Class Logit Model |
+---------------------------------------------+
+---------+--------------+----------------+--------+---------+
+---------+--------------+----------------+--------+---------+
Utility parameters in latent class -->> 1
BF|1 3.02569837 .14335927 21.106 .0000
BQ|1 -.08781664 .12271563 -.716 .4742
BP|1 -9.69638056 1.40807055 -6.886 .0000
BN|1 1.28998874 .14533927 8.876 .0000
BF|2
BQ|2
1.19721944
1.11574955
.10652336
.09712630
11.239
11.488
.0000
.0000
Estimated
BP|2
BN|2
-13.9345351
-.43137842
1.22424326
.10789864
-11.382
-3.998
.0000
.0001 Latent Class
BF|3
BQ|3
BP|3
-.17167791
2.71880759
-8.96483046
.10507720
.11598720
1.31314897
-1.634
23.441
-6.827
.1023
.0000
.0000
Model
BN|3 .18639318 .12553591 1.485 .1376
This is THETA(1) in class probability model.
Constant -.90344530 .34993290 -2.582 .0098
_MALE|1 .64182630 .34107555 1.882 .0599
_AGE25|1 2.13320852 .31898707 6.687 .0000
_AGE39|1 .72630019 .42693187 1.701 .0889
Constant .37636493 .33156623 1.135 .2563
_MALE|2 -2.76536019 .68144724 -4.058 .0000
_AGE25|2 -.11945858 .54363073 -.220 .8261
_AGE39|2 1.97656718 .70318717 2.811 .0049
Constant .000000 ......(Fixed Parameter).......
_MALE|3 .000000 ......(Fixed Parameter).......
_AGE25|3 .000000 ......(Fixed Parameter).......
_AGE39|3 .000000 ......(Fixed Parameter).......
Latent Class Elasticities

+-----------------------------------------------------------------+
| Elasticity Averaged over observations. |
| Effects on probabilities of all choices in the model: |
| Attribute is PRICE in choice B1 MNL LCM |
| * Choice=B1 .000 .000 .000 -.889 -.801 |
| Choice=B2 .000 .000 .000 .291 .273 |
| Choice=B3 .000 .000 .000 .291 .248 |
| Choice=NONE .000 .000 .000 .291 .219 |
| Attribute is PRICE in choice B2 |
| Choice=B1 .000 .000 .000 .313 .311 |
| * Choice=B2 .000 .000 .000 -1.222 -1.248 |
| Choice=B3 .000 .000 .000 .313 .284 |
| Choice=NONE .000 .000 .000 .313 .268 |
| Choice=B1 .000 .000 .000 .366 .314 |
| Choice=B2 .000 .000 .000 .366 .344 |
| * Choice=B3 .000 .000 .000 -.755 -.674 |
| Choice=NONE .000 .000 .000 .366 .302 |
+-----------------------------------------------------------------+
Individual Specific Means

A Practical Distinction
Finite Mixture (Discrete Mixture):

Functional form strategy
Component densities have no meaning
Mixing probabilities have no meaning
There is no question of class membership
The number of classes is uninteresting enough to get a good fit
Latent Class:
Mixture of subpopulations
Component densities are believed to be definable groups
(Low Users and High Users in Bago dUva and Jones
application)
The classification problem is interesting who is in which class?
Posterior probabilities, P(class|y,x) have meaning
Question of the number of classes has content in the context of
the analysis
The Latent Class Model
(1) There are Q classes, unobservable to the analyst

(2) Class specific model: f(y it | x it , class q) g(y it , x it , q )
(3) Conditional class probabilities (possibly given some
information, zi ) P(class=q|zi , )
Common multinomial logit form for prior class probabilities
exp(zi q )
P(class=q|zi , ) iq Q , Q = 0
q1 exp(ziq )
Note, if no zi , q = log(iq / iQ ).
Estimating an LC Model
Conditional density for each observation is
P(y i,t | x i,t , class q) f(y it | x i,t , q )
Joint conditional density for Ti observations is
f(y i1 , y i2 ,..., y i,Ti | X i , q ) t i 1 f(y it | x i,t , q )
T
(Ti may be 1. This is not only a 'panel data' model.)

Maximize this for each class if the classes are known.
They aren't. Unconditional density for individual i is
f(y i1 , y i2 ,..., y i,Ti | X i , zi ) q1 iq
Q
Ti
t 1
f(y it | x i,t , q )
LogLikelihood
LogL(1 ,..., Q , 1 ,..., Q ) i1 log q1 iq t i 1 f(y it | x i,t , q )
N Q T
Estimating Which Class

Prior class probability Prob[class=q|z i ]=iq
Joint conditional density for Ti observations is
P(y i1 , y i2 ,..., y i,Ti | X i , class q) t i 1 f(y it | x i,t , q )
T
Joint density for data and class membership is the product

P(y i1 , y i2 ,..., y i,Ti , class q | X i , zi ) q t i 1 f(y it | x i,t , q )
T
Posterior probability for class, given the data

P( y i , class q | X i , zi )
P(class q | y i1 , y i2 ,..., y i,Ti , X i , zi )
P(y i1 , y i2 ,..., y i,Ti | X i , zi )

Q
q1
Use Bayes Theorem to compute the posterior (conditional) probability
iq t i 1 f(y it | x i,t , q )
T
w(q | y i , X i , zi ) P(class j | y i , X i , zi )
iq t i 1 f(y it | x i,t , q )
Q T
q1
w iq
Best guess = the class with the largest posterior probability.
Estimating i
from the class with the largest estimated probability
(1) Use j
(2) Probabilistic - in the same spirit as the 'posterior mean'

= Q Posterior Prob[class=q|data ]

i q=1 i q
= q=1 w
Q
iq q
Note : This estimates E[i | y i , X i , zi ], not i itself.

How Many Classes?
(1) Q is not a 'parameter' - can't 'estimate' Q with

and
(2) Can't 'test' down or 'up' to Q by comparing
log likelihoods. Degrees of freedom for Q+1
vs. Q classes is not well defined.
(3) Use AKAIKE IC; AIC = -2 logL + 2#Parameters.
Modeling Obesity with a

Latent Class Model
Mark Harris
Department of Economics, Curtin University
Bruce Hollingsworth
Department of Economics, Lancaster University
Pushkar Maitra
Department of Economics, Monash University
William Greene
Stern School of Business, New York University
300 Million People Worldwide. International Obesity Task Force: www.iotf.org

Costs of Obesity
In the US more people are obese than smoke or
use illegal drugs
Obesity is a major risk factor for non-
communicable diseases like heart problems and
cancer
Obesity is also associated with:
lower wages and productivity, and absenteeism
low self-esteem
An economic problem. It is costly to society:
USA costs are around 4-8% of all annual health care
expenditure - US $100 billion
Canada, 5%; France, 1.5-2.5%; and New Zealand
2.5%
Measuring Obesity
An individuals weight given their height should
lie within a certain range
Body Mass Index (BMI)
Weight (Kg)/height(Meters)2
World Health Organization guidelines:
Underweight BMI < 18.5
Normal 18.5 < BMI < 25
Overweight 25 < BMI < 30
Obese BMI > 30
Morbidly Obese BMI > 40
Two Latent Classes: Approximately Half of European Individuals

Modeling BMI Outcomes

Grossman-type health production function
Health Outcomes = f(inputs)
Existing literature assumes BMI is an ordinal, not cardinal,
representation of individuals.
Weight-related health status
Do not assume a one-to-one relationship between BMI levels and
(weight-related) health status levels
Translate BMI values into an ordinal scale using WHO
guidelines
Preserves underlying ordinal nature of the BMI index but
recognizes that individuals within a so-defined weight range
are of an (approximately) equivalent (weight-related) health
status level
Conversion to a Discrete Measure

Measurement issues: Tendency to
under-report BMI
women tend to under-estimate/report
weight;
men over-report height.
Using bands should alleviate this
Allows focus on discrete at risk groups
A Censored Regression Model for BMI

Simple Regression Approach Based on Actual BMI:
BMI* = x + , ~ N[0,2] , 2 = 1
True BMI = weight proxy is unobserved
Interval Censored Regression Approach
WT = 0 if BMI* < 25 Normal
1 if 25 < BMI* < 30 Overweight
2 if BMI* > 30 Obese
Inadequate accommodation of heterogeneity

Inflexible reliance on WHO classification
Rigid measurement by the guidelines
Heterogeneity in the BMI Ranges
Boundaries are set by the WHO narrowly defined for all individuals
Strictly defined WHO definitions may consequently push individuals

into inappropriate categories
We allow flexibility at the margins of these intervals
Following Pudney and Shields (2000) therefore we consider

Generalised Ordered Choice models - boundary parameters are
now functions of observed personal characteristics
Generalized Ordered Probit Approach

A Latent Regression Model for True BMI
BMIi* = xi + i , i ~ N[0,2], 2 = 1
Observation Mechanism for Weight Type
WTi = 0 if BMIi* < 0 Normal
1 if 0 < BMIi* < i(wi) Overweight
2 if (wi) < BMIi* Obese
Latent Class Modeling

Several types or classes. Obesity be due to genetic
reasons (the FTO gene) or lifestyle factors
Distinct sets of individuals may have differing reactions

to various policy tools and/or characteristics
The observer does not know from the data which class
an individual is in.
Suggests a latent class approach for health outcomes

(Deb and Trivedi, 2002, and Bago dUva, 2005)
Latent Class Application

Two class model (considering FTO gene):
More classes make class interpretations much more
difficult
Parametric models proliferate parameters
Endogenous class membership: Two classes

allow us to correlate the equations driving class
membership and observed weight outcomes via
unobservables.
Heterogeneous Class Probabilities

j = Prob(class=j) = governor of a detached
natural process. Homogeneous.
ij = Prob(class=j|zi,individual i)
Now possibly a behavioral aspect of the
process, no longer detached or natural
Nagin and Land 1993, Criminal Careers
Endogeneity of Class Membership

Class Membership: C* = z i ui , C = 1[C* > 0] (Probit)
BMI|Class=0,1 BMI* = c xi c ,i , BMI group = OP[BMI*,(c w i )]
ui 0 1 c
Endogeneity: ~ N ,
c ,i 0 c 1
Bivariate Ordered Probit (one variable is binary).
Full information maximum likelihood.

Model Components
x: determines observed weight levels within classes

For observed weight levels we use lifestyle factors such
as marital status and exercise levels
z: determines latent classes
For latent class determination we use genetic proxies
such as age, gender and ethnicity: the things we
cant change
w: determines position of boundary parameters within
classes
For the boundary parameters we have: weight-
training intensity and age (BMI inappropriate for the
aged?) pregnancy (small numbers and length of term
unknown)
Data
US National Health Interview Survey
(2005); conducted by the National
Center for Health Statistics
Information on self-reported height and
weight levels, BMI levels
Demographic information
Split sample (30,000+) by gender
Outcome Probabilities
Class 0 dominated by normal and overweight probabilities normal weight class
Class 1 dominated by probabilities at top end of the scale non-normal weight
Unobservables for weight class membership, negatively correlated with those
determining weight levels:
Normal Overweight Obese Class 1

Class 0
Normal Overweight Obese

Classification (Latent Probit) Model

BMI Ordered Choice Model

Conditional on class membership, lifestyle factors
Marriage comfort factor only for normal class women
Both classes associated with income, education
Exercise effects similar in magnitude
Exercise intensity only important for non-normal class:
Home ownership only important for .non-normal.class, and negative:
result of differing socieconomic status distributions across classes?
Effects of Aging on Weight Class

Effect of Education on Probabilities

Effect of Income on Probabilities

Inflated Responses in Self-Assessed Health

Mark Harris
Department of Economics, Curtin University
Bruce Hollingsworth
Department of Economics, Lancaster University
William Greene
Stern School of Business, New York University
Introduction
Health sector an important part of developed countries
economies: E.g., Australia 9% of GDP
To see if these resources are being effectively utilized,
we need to fully understand the determinants of
individuals health levels
To this end much policy, and even more academic
research, is based on measures of self-assessed health
(SAH) from survey data
SAH vs. Objective Health Measures

Favorable SAH categories seem artificially high.
60% of Australians are either overweight or obese (Dunstan et. al, 2001)
1 in 4 Australians has either diabetes or a condition of impaired glucose
metabolism
Over 50% of the population has elevated cholesterol
Over 50% has at least 1 of the deadly quartet of health conditions
(diabetes, obesity, high blood pressure, high cholestrol)
Nearly 4 out of 5 Australians have 1 or more long term health conditions
(National Health Survey, Australian Bureau of Statistics 2006)
Australia ranked #1 in terms of obesity rates
Similar results appear for other countries
SAH vs. Objective Health
1. Are these SAH outcomes are over-

inflated
2. And if so, why, and what kinds of people

are doing the over-inflating/mis-
reporting?
HILDA Data
The Household, Income and Labour Dynamics in

Australia (HILDA) dataset:
1. a longitudinal survey of households in Australia
2. well tried and tested dataset
3. contains a host of information on SAH and other health
measures, as well as numerous demographic variables
Self Assessed Health

In general, would you say your health is: Excellent,
Very good, Good, Fair or Poor?"
Responses 1,2,3,4,5 (we will be using 0,1,2,3,4)
Typically of responses are good or very good
health; in our data (HILDA) we get 72%
Similar numbers for most developed countries
Does this truly represent the health of the nation?
A Two Class Latent Class Model
True Reporter Misreporter

Reporter Type Model

r* xrr r
r = 1 if r* > 0 True reporter
0 if r* 0 Misreporter
r is unobserved
Y=4
Y=3
Y=2
Y=1
Y=0
Pr(true,y) = Pr(true) * Pr(y | true)

Mis-reporters choose either good or very good

The response is determined by a probit model
m* xm m m
Y=3
Y=2
Observed Mixture of Two Classes

Pr( y ) Pr(true) Pr( y | true) Pr(misreporter ) Pr( y | misreporter )

Who are the Misreporters?

Priors and Posteriors

M=Misreporter, T=True reporter
Priors : Pr( M ) ( xr), Pr(T ) ( xr)
Posteriors:
Noninflated outcomes 0, 1, 4
Pr( M | y 0,1, 4) 0, Pr(T | y 0,1, 4) ( xr)
Inflated outcomes 2, 3
Pr( y 2 | M )Pr( M )
Pr( M | y 2)
Pr( y 2 | M )Pr( M ) Pr( y 2 | T )Pr(T )
General Results
Latent Class Efficiency Studies
Battese and Coelli growing in weather

regimes for Indonesian rice farmers
Kumbhakar and Orea cost structures for U.S.

Banks
Greene (Health Economics, 2005) revisits

WHO Year 2000 World Health Report
Studying Economic Efficiency

in Health Care
Hospital and Nursing Home

Cost efficiency
Role of quality (not studied today)
Agency for Health Reseach and Quality
(AHRQ)
Stochastic Frontier Analysis
logC = f(output, input prices, environment) + v

+u
= v+u
v = noise the usual disturbance
u = inefficiency
Frontier efficiency analysis
Estimate parameters of model
Estimate u (to the extent we are able we use
E[u|])
Evaluate and compare observed firms in the sample
Nursing Home Costs
44 Swiss nursing homes, 13 years

Cost, Pk, Pl, output, two environmental
variables
Estimate cost function
Estimate inefficiency
Estimated Cost Efficiency

Inefficiency?
Not all agree with the presence (or
identifiability) of inefficiency in market
outcomes data.
Variation around the common production
structure may all be nonsystematic and not
controlled by management
Implication, no inefficiency: u = 0.
A Two Class Model

Class 1: With Inefficiency
logC = f(output, input prices, environment) + vv + uu
Class 2: Without Inefficiency
logC = f(output, input prices, environment) + vv
u = 0
Implement with a single zero restriction in a
constrained (same cost function) two class model
Parameterization: = u /v = 0 in class 2.
LogL= 464 with a common frontier

model, 527 with two classes
Random Parameters (Mixed) Models
A General Model Structure

f(y it | x it , i ) g(y it | x it , i , )
i = a set of random parameters = + ui
f(i |zi ) = h(i , zi , )
= a set of nonrandom parameters in the density of y it
= a set of parameters in the distribution of i
Typical application "repeated measures" = panel
The "mixed" model
f(y it | x it , zi , , )
i
f(y it | x it , i , )h(i , zi , )di
forms the basis of a likelihood function for the observed data.

Mixed Model Estimation

WinBUGS:
MCMC
User specifies the model constructs the Gibbs Sampler/Metropolis Hastings
SAS: Proc Mixed.
Classical
Uses primarily a kind of GLS/GMM (method of moments algorithm for loglinear models)
Stata: Classical
Mixing done by quadrature. (Very slow for 2 or more dimensions)
Several loglinear models - GLAMM
LIMDEP/NLOGIT
Classical
Mixing done by Monte Carlo integration maximum simulated likelihood
Numerous linear, nonlinear, loglinear models
Ken Trains Gauss Code
Monte Carlo integration
Used by many researchers
Mixed Logit (mixed multinomial logit) model only (but free!)
Programs differ on the models fitted, the algorithms, the paradigm, and the
extensions provided to the simplest RPM, i = +wi.
Modeling Parameter Heterogeneity
Conditional Model, linear or nonlinear

density : f(y i,t | x i,t , i , ) g(y i,t , x i,t , i , )
Individual heterogeneity in the means of the parameters
i = zi + ui , E[ui | X i , zi ] 0
Heterogeneity in the variances of the parameters
Var[ui,k | zi ] ik k exp(zik )
Var[ui | zi ] = i = diag(ik )
(Different variables in zi may appear in means and variances.)
Free correlation: Var[ui | zi ] = i = i', = a lower triangular
matrix with 1s on the diagonal.
A Mixed Probit Model
Random parameters probit model

f(y it | x it , i ) [(2y it 1) x it i ]
i + ui
ui ~ N[0, ], = 2'
= diagonal matrix of standard deviations
= I lower triangular matrix or I if uncorrelated
LogL(, , )= i=1 log t 1
N Ti
[(2y it 1) x
it i ] N[ , 2
']d i
i
Maximum Simulated Likelihood
logL(, )=

N T
i=1
log t 1
f(y it | x it , i , )h(i | zi , )di
i
= , , 1 ,..., K , 1 ,..., K ,
Simulated Log Likelihood for a Mixed

Probit Model
Random parameters probit model
f(y it | x it , i ) [(2y it 1) x it i ]
i + ui
ui ~ N[0, 2']
LogL(, )= i=1 log t 1
N Ti
[(2y it 1) x
it i ] N[ , 2
']di
i
1 R
LogL i=1 log r 1 t 1 [(2y it 1) x it ( + v ir )]
S N Ti
R
We now maximize this function with respect to ( , , ).
Application Doctor Visits

German Health Care Usage Data, 7,293 Individuals, Varying Numbers of Periods
Variables in the file are
Data downloaded from Journal of Applied Econometrics Archive. This is an unbalanced panel with 7,293
individuals. They can be used for regression, count models, binary choice, ordered choice, and bivariate binary
choice. This is a large data set. There are altogether 27,326 observations. The number of observations ranges
from 1 to 7. (Frequencies are: 1=1525, 2=2158, 3=825, 4=926, 5=1051, 6=1000, 7=987). Note, the variable
NUMOBS below tells how many observations there are for each person. This variable is repeated in each row of
the data for the person.
DOCTOR = 1(Number of doctor visits > 0)
HSAT = health satisfaction, coded 0 (low) - 10 (high)
DOCVIS = number of doctor visits in last three months
HOSPVIS = number of hospital visits in last calendar year
PUBLIC = insured in public health insurance = 1; otherwise = 0
ADDON = insured by add-on insurance = 1; otherswise = 0
HHNINC = household nominal monthly net income in German marks / 10000.
(4 observations with income=0 were dropped)
HHKIDS = children under age 16 in the household = 1; otherwise = 0
EDUC = years of schooling
AGE = age in years
MARRIED = marital status
EDUC = years of education
Estimates of a Mixed Probit Model

+---------------------------------------------+
| Random Coefficients Probit Model |
| Dependent variable DOCTOR |
| Restricted log likelihood -17700.96 |
| Unbalanced panel has 7293 individuals. |
+---------------------------------------------+
+---------+--------------+----------------+--------+---------+----------+
|Variable | Coefficient | Standard Error |b/St.Er.|P[|Z|>z] | Mean of X|
+---------+--------------+----------------+--------+---------+----------+
Means for random parameters
Constant -.09594899 .04049528 -2.369 .0178
AGE .02102471 .00053836 39.053 .0000 43.5256898
HHNINC -.03119127 .03383027 -.922 .3565 .35208362
EDUC -.02996487 .00265133 -11.302 .0000 11.3206310
MARRIED -.03664476 .01399541 -2.618 .0088 .75861817
+---------+--------------+----------------+--------+---------+----------+
Constant .02642358 .05397131 .490 .6244
AGE .01538640 .00071823 21.423 .0000 43.5256898
HHNINC -.09775927 .04626475 -2.113 .0346 .35208362
EDUC -.02811308 .00350079 -8.031 .0000 11.3206310
MARRIED -.00930667 .01887548 -.493 .6220 .75861817
Random Parameters Probit

Diagonal elements of Cholesky matrix
Constant .55259608 .05381892 10.268 .0000
AGE .279052D-04 .00041019 .068 .9458
HHNINC .03545309 .04094725 .866 .3866
EDUC .00994387 .00093271 10.661 .0000
MARRIED .01013553 .00643526 1.575 .1153
Below diagonal elements of Cholesky matrix
lAGE_ONE .00668600 .00071466 9.355 .0000
lHHN_ONE -.23713634 .04341767 -5.462 .0000
lHHN_AGE .09364751 .03357731 2.789 .0053
lEDU_ONE .01461359 .00355382 4.112 .0000
lEDU_AGE -.00189900 .00167248 -1.135 .2562
lEDU_HHN .00991594 .00154877 6.402 .0000
lMAR_ONE -.04871097 .01854192 -2.627 .0086
lMAR_AGE -.02059540 .01362752 -1.511 .1307
lMAR_HHN -.12276339 .01546791 -7.937 .0000
lMAR_EDU .09557751 .01233448 7.749 .0000
Application Shoe Brand Choice

Simulated Data: Stated Choice, 400 respondents, 8 choice
situations
3 choice/attributes + NONE
Fashion = High=1 / Low=0
Quality = High=1 / Low=0
Price = 25/50/75,100,125 coded 1,2,3,4,5 then divided by 25.
Heterogeneity: Sex, Age (<25, 25-39, 40+) categorical

Underlying data generated by a 3 class latent class process (100,
200, 100 in classes)
Thanks to www.statisticalinnovations.com (Latent Gold and Jordan
Louviere)
A Discrete (4 Brand) Choice Model with Heterogeneous

and Heteroscedastic Random Parameters
Ui,1,t = F,i Fashioni,1,t + Q Quality i,1,t +P,i Pricei,1,t + i,1,t

Ui,NONE,t = NONE + i,NONE,t
F,i = F + FSex i +[ F exp( F1 AgeL25i + F2 Age2539i )] w F,i ; w F,i ~ N[0,1]
P,i = P + PSex i +[ P exp( P1 AgeL25i + P2 Age2539i )] w P,i ; w P,i ~ N[0,1]
Multinomial Logit Model Estimates

Mixed Logit Estimates

+---------------------------------------------+
| Random Parameters Logit Model |
| At start values -4158.5029 .05929 .05811 |
+---------------------------------------------+
+---------+--------------+----------------+--------+---------+
+---------+--------------+----------------+--------+---------+
Random parameters in utility functions
BF 1.46523951 .12626655 11.604 .0000
BQ 1.14369857 .16954024 6.746 .0000
Nonrandom parameters in utility functions
BP -12.1098155 .91584476 -13.223 .0000
BN .17706909 .07784730 2.275 .0229
Heterogeneity in mean, Parameter:Variable
BF:MAL .28052695 .14266576 1.966 .0493
BQ:MAL -.42310284 .20387789 -2.075 .0380
Derived standard deviations of parameter distributions
NsBF 1.16430284 .13731611 8.479 .0000
NsBQ 1.81872569 .18108194 10.044 .0000
Heteroscedasticity in random parameters
sBF|AG -.32466344 .16986949 -1.911 .0560
sBF0|AG -.51032609 .23975740 -2.129 .0333
sBQ|AG -.37953350 .13798031 -2.751 .0059
sBQ0|AG -.41636803 .17143046 -2.429 .0151
Estimated Elasticities
+--------------------------------------------------------------+
| Elasticity Averaged over observations. |
| Effects on probabilities of all choices in the model: |
| Attribute is PRICE in choice B1 RPL MNL LCM |
| * Choice=B1 .000 .000 -.818 -.889 -.801 |
| Choice=B2 .000 .000 .240 .291 .273 |
| Choice=B3 .000 .000 .244 .291 .248 |
| Choice=NONE .000 .000 .241 .291 .219 |
| Choice=B1 .000 .000 .291 .313 .311 |
| * Choice=B2 .000 .000 -1.100 -1.222 -1.248 |
| Choice=B3 .000 .000 .270 .313 .284 |
| Choice=NONE .000 .000 .276 .313 .268 |
| Choice=B1 .000 .000 .287 .366 .314 |
| Choice=B2 .000 .000 .326 .366 .344 |
| * Choice=B3 .000 .000 -.647 -.755 -.674 |
| Choice=NONE .000 .000 .311 .366 .302 |
+--------------------------------------------------------------+
Conditional Estimators
Counterpart to Bayesian posterior mean and variance
= argmax N log 1 R
i=1 R r=1 t=1 Pijt (ir | ,datait )
Ti
Ti
L =
i P ( | ,data
t=1

ijt )
i it
(1/R)Rr=1i,k,r Tt=1Pijt ( i | ,data

it ) 1 R
E[ i,k | datai ] =
(1/R)R
P ( | ,data ) R
T
= r=1
w
i,r i,k,r
r=1 t=1 ijt i it
(1/R)Rr=1i,k,r
2
Tt=1Pijt ( i | ,data

it ) 1 R
E[ 2
i,k | datai ] =
(1/R)R T P ( | ,data
=
) R r=1
w
i,r i,k,r
2
r=1 t=1 ijt i it

2
Var[i,k 2 | data ] - E[
| datai ] = E[
i,k i i,k | d atai ]
E[ i,k | datai ] 2 Var[ i,k | datai ] will encompass 95% of any
reasonable distribution
Individual E[i|datai] Estimates

Disaggregated Parameters
The description of classical methods as only producing aggregate results
is obviously untrue.
As regards targeting specific groups both of these sets of methods

produce estimates for the specific data in hand. Unless we want to trot
out the specific individuals in this sample to do the analysis and marketing,
any extension is problematic. This should be understood in both
paradigms.
NEITHER METHOD PRODUCES ESTIMATES OF INDIVIDUAL

PARAMETERS, CLAIMS TO THE CONTRARY NOTWITHSTANDING. BOTH
PRODUCE ESTIMATES OF THE MEAN OF THE CONDITIONAL
(POSTERIOR) DISTRIBUTION OF POSSIBLE PARAMETER DRAWS
CONDITIONED ON THE PRECISE SPECIFIC DATA FOR INDIVIDUAL I.
Appendix: EM Algorithm
The EM Algorithm
Latent Class is a 'missing data' model
di,j 1 if individual i is a member of class j
If di,j were observed, the complete data log likelihood would be
logL c i1 log
N
d
J i T

j1 i,j t 1 f(y i,t | datai,t , class j)

(Only one of the J terms would be nonzero.)

Expectation - Maximization algorithm has two steps
(1) Expectation Step: Form the 'Expected log likelihood'
given the data and a prior guess of the parameters.
(2) Maximize the expected log likelihood to obtain a new
guess for the model parameters.
(E.g., http://crow.ee.washington.edu/people/bulyko/papers/em.pdf)
Implementing EM
Given initial guesses iq0 i10 , i20 ,..., iQ
0
, 0q i10 , i20 ,..., iq0
E.g., use 1/Q for each iq and the MLE of from a one class
model. (Have to perturb each one slightly, as if all iq are equal
and all q are the same, the model will satisfy the FOC.)

(1) Compute w(q|i) 0 ,
= posterior class probabilities, using 0
Reestimate each q using a weighted log likelihood
i=1 w iq
N Ti
Maximize wrt q t=1
log f(y it | x i1 , q )
(2) Reestimate iq by reestimating q
If no zi , new
q=(1/N)Ni=1w(q|i) and new
using old
exp(zi q )
i=1 w(q|i)
N
If zi , Maximize wrt q log
Qq=1exp(zi q )
Now, return to step 1.
Iterate until convergence.
Appendix: Monte Carlo Integration

Monte Carlo Integration

(1) Integral is of the form
K= range of v
g(v|data,) f(v|) dv
where f(v) is the density of random variable v
possibly conditioned on a set of parameters
and g(v|data,) is a function of data and parameters.
(2) By construction, K() = E[g(v|data,)]
(3) Strategy:
a. Sample R values from the population
of v using a random number generator.
b. Compute average K = (1/R) r=1 g(v r|data,)
R
By the law of large numbers, plim K = K.

Monte Carlo Integration
1 R

R r 1
f (uir )
P
f (ui ) g (ui )dui Eui [ f (ui )]
ui
(Certain smoothness conditions must be met .)

Drawing uir by 'random sampling'
uir t (vir ), vir ~ U [0,1]
E.g ., uir 1 (vir ) for N [, 2 ]
Requires many draws, typically
hundreds or thousands
Example: Monte Carlo Integral
exp( v 2 / 2)
(x1 .9v)(x 2 .9v)(x 3 .9v)

2
dv
where is the standard normal CDF and x 1 = .5,

x 2 = -.2, x 3 = .3. (Looks like a RE probit model.)
The weighting function for v is the standard normal.
Strategy: Draw R (say 1000) standard normal random
draws, v r . Compute the 1000 functions
(x1 .9v)(x 2 .9v)(x 3 .9v) and average them.
(Based on 100, 1000, 10000, I get .28746, .28437, .27242)
Generating a Random Draw

Most common approach is the "inverse probability transform"
Let u = a random draw from the standard uniform (0,1).
Let x = the desired population to draw from
Assume the CDF of x is F(x).
The random draw is then x = F -1 (u).
Example : exponential, . f(x)=exp(-x), F(x)=1-exp(-x)
Equate u to F(x), x = -(1/)log(1-u).
Example: Normal(,). Inverse function does not exist in
closed form. There are good polynomial approxi-
mations to produce a draw from N[0,1] from a U(0,1).
Then x = +v.
This leaves the question of how to draw the U(0,1).
Drawing Uniform Random Numbers

Computer generated random numbers are not random; they
are Markov chains that look random.
The Original Random Number Generator for 32 bit computers.
SEED originates at some large odd number
d3 = 2147483647.0
d2 = 2147483655.0
d1=16807.0
SEED=Mod(d1*SEED,d3) ! MOD(a,p) = a - INT(a/p) * p
X=SEED/d2 is a random value between 0 and 1.
Problems:
(1) Short period. Based on 32 bits, so recycles after 231 1 values
(2) Evidently not very close to random. (Recent tests have
discredited this RNG)
LEcuyers RNG
Define: norm = 2.328306549295728e-10,
m1 = 4294967087.0, m1 = 4294944443.0,
a12 = 140358.0, a13n = 810728.0,
a21 = 527612.0, a23n = 1370589.0,
Initialize s10 = the seed, s11 = 4231773.0,
s12 = 1975.0, s20 = 137228743.0,
s21 = 98426597.0, s22 = 142859843.0.
Preliminaries for each draw (Resets at least some of 5 seeds)
p1 = a12*s11 - a13n*s10, k = int(p1/m1), p1 = p1 - k*m1
if p1 < 0, p1 = p1 + m1, s10 = s11, s11 = s12, s12 = p1;
p2 = a21*s22 - a23n*s20, k = int(p2/m2), p2 = p2 - k*m2
if p2 < 0, p2 = p2 + m2, s20 = s21, s21 = s22, s22 = p2;
Compute the random number
u = norm*(p1 - p2) if p1 > p2,
u = norm*(p1 - p2 + m1) otherwise.
Passes all known randomness tests. Period = 2191
Pierre L'Ecuyer. Canada Research Chair in Stochastic Simulation and

Optimization. Dpartement d'informatique et de recherche oprationnelle
University of Montreal.
Quasi-Monte Carlo Integration Based on

Halton Sequences
Coverage of the unit interval is the objective,
not randomness of the set of draws.
Halton sequences --- Markov chain
p = a prime number,

I
r= the sequence of integers, decomposed as i 0
bi p i
H(r|p) i 0 bi p i 1 , r = r1 ,... (e.g., 10,11,12,...)
I
For example, using base p=5, the integer r=37 has b0 =

2, b1 = 2, and b3 = 1; (37=1x52 + 2x51 + 2x50). Then
H(37|5) = 25-1 + 25-2 + 15-3 = 0.448.
Halton Sequences vs.

Random Draws
Requires far fewer draws for one dimension, about 1/10.

Accelerates estimation by a factor of 5 to 10.

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Part 23: Parameter Heterogeneity [1/115]

Econometric Analysis of Panel Data

Econometric Analysis of Panel Data

23. Individual Heterogeneity

Observational: Observable differences across

Choice strategy: How consumers make

Structural: Differences in model frameworks

(1) Regression model

Distinguish Bayes and Classical

Fixed Management and Technical Efficiency

Antonio Alvarez, University of Oviedo

The Production Function Model

Application to Spanish Dairy Farms

N = 247 farms, T = 6 years (1993-1998)

Input Units Mean Std. Dev. Minimum Maximum

Milk Milk production (liters) 131,108 92,539 14,110 727,281

Cows # of milking cows 2.12 11.27 4.5 82.3

Labor # man-equivalent units 1.67 0.55 1.0 4.0

Land Hectares of land devoted 12.99 6.17 2.0 45.1

Feed Total amount of feedstuffs 57,941 47,981 3,924.14 376,732

Translog Production Model

uit = ln yit* - ln yit

Random Coefficients Model

Discrete vs. Continuous Variation

Discrete Parameter Variation

The Latent Class Model

How Finite Mixture Models Work

Find the Best Fitting Mixture of Two Normal Densities

F(y) = .28547 1 y - 7.05737 1 y - 3.25966

Mixing probabilities .715 and .285

Application Shoe Brand Choice

Heterogeneity: Sex, Age (<25, 25-39, 40+) categorical

A Random Utility Model

= Taste weights, Part worths, marginal utilities

ijt = Unobserved random component of utility

The Multinomial Logit Model

Latent Classes and Random Parameters

Latent Class Elasticities

Individual Specific Means

Finite Mixture (Discrete Mixture):

The Latent Class Model

(1) There are Q classes, unobservable to the analyst

(Ti may be 1. This is not only a 'panel data' model.)

Estimating Which Class

Joint density for data and class membership is the product

Posterior probability for class, given the data

(2) Probabilistic - in the same spirit as the 'posterior mean'

Note : This estimates E[i | y i , X i , zi ], not i itself.

How Many Classes?

(1) Q is not a 'parameter' - can't 'estimate' Q with

Modeling Obesity with a

300 Million People Worldwide. International Obesity Task Force: www.iotf.org

Two Latent Classes: Approximately Half of European Individuals

Modeling BMI Outcomes

Conversion to a Discrete Measure

A Censored Regression Model for BMI

Inadequate accommodation of heterogeneity

Heterogeneity in the BMI Ranges

Strictly defined WHO definitions may consequently push individuals

We allow flexibility at the margins of these intervals

Following Pudney and Shields (2000) therefore we consider

Generalized Ordered Probit Approach

Latent Class Modeling