README.md

fully endogenized finite mixture model

R, Julia and Python implementation of the fully endogenized finite mixture model used in forthcoming articles by Fuad and Farmer (202-) and Fuad, Farmer, and Abidemi (202-). Codes presented are for two submarkets that can be modified for more than two submarkets.

This model employs a finite mixture model to sort households into endogenously determined latent submarkets. The finite mixture model to predict home prices is:

$h(P_i | x_i, \beta_j, p_j)=\sum_{j=1} \pi(z_i)f(P_i|x_i, \beta_j)$

The mixing model $\pi(z_i)$, is used to assign each observation a percentage chance of belonging to each latent submarket and $f(.)$ is a submarket specific conditional hedonic regression. The home price is therefore a weighted average of predicted values across submarkets weighted by the probability of being located in the submarket.

We also define $d_i = (d_{i1}, d_{i2}, ..., d_{im})$ to be binary variables that indicate the inclusion of household $i$ into each latent group. These are incorporated into the likelihood function based on a logistic function which are conditional on factors that do not directly influence the price of the house.

Since the submarket identification ($d$) is not directly observable, an expectation maximization (EM) algorithm is used to estimate the likelihood of class identification: $d_{ij}=\frac{\pi_j f_j (P_i | x_i, \beta_j)}{\sum_{j=1} \pi_j f_j (P_i | x_i, \beta_j)}$

The Expectation step – the E step – involves imputation of the expected value of $d_i$ given the mixing covariates, interim estimates of $\gamma, \beta, \pi$. The Maximization step – the M step – involves using estimates of $d_i$ from the E step to update the component fractions of $\pi_j$ and $\beta$. The EM algorithm can be summarized as:

1. Generate starting values for $\gamma, \beta, \pi$

2. Initiate iteration counter for the E-step, $t$ (initial $t$ at 0)

3. Use $\beta^t$ and $\pi^t$ from Step 2 to calculate provisional $d^t$ from $d_{ij}=\frac{e^{\gamma_j z_i}}{1+\sum_{C=1}e^{\gamma_j z_i}}$

4. Initiate second iteration counter, $v$, for the M-step

5. Interim estimators of $d^{t+1}$ are then used to impute new estimates of $\beta^{v+1}$ and $\pi^{v+1}$ with $d_{ij}=\frac{\pi_j f_j (P_i | x_i, \beta_j)}{\sum_{j=1} \pi_j f_j (P_i | x_i, \beta_j)}$

6. For each prescribed latent class, estimators of $\beta^{v+1}$ are imputed, via M-step, as well as $\pi^{v+1}$

7. Increase $v$ counter by 1, and repeat M-step until: $f(\beta^{v+1}y, x, \pi, d) - f(\beta^vy, x, \pi, d) < \alpha$ prescribed constant; if yes, then $\beta^{t+1}=\beta^{v+1}$

8. Increase $t$ counter and continue from Step 3 until: $f(\beta^{t+1}, \pi^{t+1}, d | y) - f(\beta^t, \pi^t, d | y) < \alpha$ prescribed constant

$d_{ij}$ is estimated simultaneously with the estimation of the hedonic regression parameters, which are conditional on class identification:

This process is repeated until there is no change in the likelihood function: $LogL = \sum_{i=1} \sum_{j=1} d_{ij} log[f_j (P_i | x_i, \beta_j)] + d_{ij} log[\pi_j]$

The steps above, particularly from Step 3-8 do not necessarily occur sequentially as outlined above but occur simultaneously as the continual updating of estimators. Each $v$ iteration conditionally maximizes the likelihood function using interim estimates of observation latent class membership probabilities in one of the latent classes; while each $t$ iteration updates latent class memberships.

The modified hedonic regression is: $y_{ij} = d_{ij}(\beta_j X_i)+ \epsilon_{ij}$