Cemmap Working Paper (CWP08/17)

An econometric model of network formation with degree heterogeneity

Date: 10 February 2017
Publisher: The IFS
JEL classification: C31, C33, C35
DOI: 10.1920/wp.cem.2017.0817

I introduce a model of undirected dyadic link formation which allows for assortative matching on observed agent characteristics (homophily) as well as unrestricted agent level heterogeneity in link surplus (degree heterogeneity). Like in fixed effects panel data analyses, the joint distribution of observed and unobserved agent-level characteristics is left unrestricted. Two estimators for the (common) homophily parameter, β, are developed and their properties studied under an asymptotic sequence involving a single network growing large. The first, tetrad logit (TL), estimator conditions on a sufficient statistic for the degree heterogeneity. The second, joint maximum likelihood (JML), estimator treats the degree heterogeneity {Ai0}Ni=1 as additional (incidental) parameters to be estimated. The TL estimate is consistent under both sparse and dense graph sequences, whereas consistency of the JML estimate is shown
only under dense graph sequences.

Supplement for CWP 08/17