Estimating Local Network Externalities

Abstract

This paper illustrates a procedure to estimate externalities from indirect connections (so-called network externalities) using network data. This structural approach is suitable for static games of endogenous network formation with partial information, and relies on the equilibrium conditions of pairwise stability (Jackson and Wolinsky, 1996). Operationally, it consists in a two-step estimator which addresses omitted variable endogeneity. When the estimation protocol is applied to risk-sharing data within a Tanzanian village, results indicate that indirect connections matter. Network externalities are found to be negative, which can be interpreted as competition over scarce resources.