Literature Review: Empirical Identification of Peer Effects

Thomas Flanagan
Advisor: Bernhard Ganglmair
Completed: Spring 2016

Department of Finance and Managerial Economics

University of Texas at Dallas
Richardson, Texas

Abstract
This paper is a literature review of peer effects in economics. It surveys peer effects in
theory, field experiments, their econometric identification, and empirical results. The primary
objective of this paper is to determine how to identify peer effects in empirical settings. I find
that the foremost problem of identification is the reflection problem, which consists of
distinguishing between exogenous and endogenous variables. I discuss econometric techniques
that can be used to resolve the reflection problem and analyze a variety of contexts in which
these techniques are applied. I examine a number of circumstances in which peer effects have
been measured and isolate variables that affect their magnitude and behavior. I find that
considering particular contexts and the types of interactions are important in understanding what
techniques to apply in future research.

1. Introduction

The primary purpose of this paper is to survey economic literature to determine strategies of
identifying peer effects. The research question I am concerned with is: how can one most
accurately identify peer effects in different contexts? This paper consists of four sections: 1)
theory, 2) field experiments, 3) econometric identification, and 4) empirical results. Following
the research question, the goal of surveying these topics is to understand of how peer effects
operate in different circumstances and how identification techniques can best be deployed to
accommodate those circumstances. The theoretical discussion is necessary, because identifying
that some broad, abstract type of peer effect exists is of no use. Identification is only so useful to
the extent to which it provides explanatory power. Identification should seek to establish what
sort of peer effects are transmitted and what sort of mechanisms transmit them in order to
generate an economic interpretation from their identification. Field experiments provide easily
measurable accounts of the different contexts in which peer effects are present; this aids in
identifying the results empirically. Review of econometric techniques most directly addresses the
research question and is vital for correct separation of endogenous variables, exogenous
variables, and correlated effects, which is at the crux of identification. A significant portion of
this paper is dedicated to explaining how different types of peer effects and different settings of
peer effects relate to distinguishing among these three effects. Finally, to aid future research
strategies, I look at empirical results as examples that combine and apply econometric techniques
to specific settings to achieve accurate measurements of peer effects.
There are two main types of peer effects that are commonly measured in the literature. First
is the observational learning effect, and second is the social utility effect. Observational learning

occurs when a person observes the behavior of another and imitates that behavior because he
believes the behavior itself will lead him to greater utility. Social utility effects occur when a
person imitates a behavior not because the behavior itself leads to better outcome but because
performing the same action as a peer results in greater utility. For example, there is a social
utility effect if a person gains more utility by seeing a movie with a friend instead of seeing it
alone. A single econometric measurement of peer effects can consist of multiple types of peer
effects and therefore needs to be decomposed in order to understand any measurements
significance.
The purpose of the field experiments section is twofold. First, the survey of experiments will
provide some background into what sort of situations peer effects exist in. I specifically examine
peer effects that are found in the following instances of decision making: retirement savings,
financial savings, energy consumption, food consumption, and leisure goods. Secondly, the
section looks at types of peer effects in experimental contexts and demonstrates how to
distinguish among them.
The largest problem that identification faces is the reflection problem. Does the average
observed behavior of a group of people reflect the peer effects the group exerts onto its
members? Or is the average behavior a result of its members influencing the group? Successful
identification of peer effects must correctly assign cause to each of these sources. For example,
consider the binary choice of choosing to keep ones property undeveloped or to develop it.
Assume that a property is more valuable if the land close to it is of the same status (undeveloped
or developed). Therefore, a peer effect model should ideally capture the extent to which a
neighboring propertys status influences another propertys status. However, the reflection

problem is that any property also influences the neighboring propertys status, obscuring that
measurement in such a model.
I dedicate a large portion of this paper to discussing techniques deployed to overcome the
reflection problem. I find three ways to best do this. First, if one possesses observable traits of
reference groups, he can distinguish between the effect that an individual exerts on the group and
the effect a group exerts on its individual members. I will call this the observable trait
identification technique. Consider observing the uses of undeveloped land. If an undeveloped
property is used for farming but the surrounding undeveloped properties have no use at all, then
the influence of the farms status on the surrounding properties statuses is greater than the
surrounding properties statuses influence on the farms status. Being surrounded by unused land
gives an owner no incentive to develop, but having a farm nearby might give at least some
incentive for neighboring properties to develop.
A second way I find to overcome the reflection problem is to use a time lagging
approach. If one can identify that the process in question takes a lengthy amount of time to
complete and observe the amount of time for that process to be completed, then one can
overcome the reflection problem. Consider if it takes a year to develop any piece of property in
an area of undeveloped land that has remained undeveloped for over a decade. If, suddenly, an
owner develops his property, it is probably due to external, non-peer effect factors. But, if in the
following years properties around the newly developed property are developed, then those
development decisions could be attributed to the peer effects from the first propertys
development. While this analysis does overcome the reflection problem, it lends itself to a
correlated effects problem. This is because the external factors that caused the first property to
develop might be correlated with the other properties development.

A third solution very applicable to empirical measurements is called partial population

identification (Moffit 2001 p. 20). This technique involves finding an event that subjects a subset
of a population to some new information or provides it a new skill. Then, one should examine
the influence of that subset of the population on the rest of the population. For example, if a
subset of undeveloped land in an area is given tax credits for development, then this would exert
influence on the surrounding properties to also develop. The surrounding lands would not
develop, however, because of the tax credit, but because the opportunity cost of keeping their
land undeveloped is higher when the surrounding land is developed.
Identification also involves being able to interpret results spatially. In context of land
usage, it is not very useful to find the average influence of properties on one another within an
enclosed geographic region. Rather, an ideal model shows how peer effects operate differently
within subsets of an enclosed geographic region. Statistical mechanics models can be
incorporated into peer effects models to capture this nuance. This design can measure individuals
or properties as particles that move in probabilistic ways as distance changes. This allows
examination of peer effects within subsections of a single geographic region.
The final section of this paper seeks to apply the identification techniques discussed in
the econometric section to empirical papers to show how some techniques are combined and
applied. Rosiers, Dub, and Thriault (2011) for example combine the time lagging approach
with the observable group characteristic approach for identification of peer effects. Additionally,
topics such as retirement which are identified using field experiments in the third section are also
identified using empirical procedures by Chalmers (2014). This shows how field experiments
may be useful in guiding empirical research in the same topic areas. Finally, Chetty et al. (2012)
offer the lesson that solving the reflection problem may not be necessary if beforehand one

identifies that social influences are asymmetrical. This lends to the overall theme of this paper
that identification techniques should be well suited to specific contexts and only need be
deployed to the extent to which there are legitimate identification problems.

2. Theoretical Aspects of Peer Effects

Peer effects occur when social interactions cause individuals to make decisions
differently than if they were not exposed to those interactions. Charles Manski is probably by far
the most defining author of the current body of economic literature on peer effects. His seminal
paper on econometric identification of peer effects published in 1993, assigns fault on prior
papers that rely on weak assumptions to infer the presence of peer effects. He proposes a novel
econometric technique to achieve more accurate estimates (Manski 1993). However, these
econometric techniques will only show how to detect peer effects broadly. Such a detection is
not of economic significance since, without context, it offers no explanatory power. Knowing the
type of peer effect allows identification to distinguish among types of peer effect in single
context. Even if there is only a single effect being measured, it is helpful to know what sort of
interaction is occurring. This is ideal since the goal of identification is to offer an economic
explanation of the mechanisms through which peer effects change decision making. Manski
(2000) discusses some of the theoretical aspects of peer effects, which help in understanding how
peer effects are transmitted and what contexts produce them.

2.1 Types of Peer Effects

Manski defines three different types of social interactions that aid this identification
process. Constraint interactions occur when a peers use of a resource results in less of that
resource available. This causes individuals to make decisions differently because the time cost
of some activities depends on the number of agents choosing them (Manski 2000, pg. 7). While
resource depletion can be conceived as a negative constraint interaction there can also exist
positive constraint interactions. When the number of agents engaged in research and
development increases it enlarges the production sets of other agents (Manski 2000, pg. 7).
While Manksi mentions constraint interactions, it is not frequent in the literature.
Expectation interactions are a commonly studied type of social interaction. The foremost
example of an expectation interaction is the disclosure of private information. Often, individuals
choices reflect private information. For example, the purchase of health insurance may reveal a
persons skills and health conditions. A commonplace expectation interaction is observational
learning in which one individual determines her expectations from the experience of others
(Manski 2000, pg. 8). This particularly true when the actions/information of a neighbor may hold
more gravity than the same information conveyed by a stranger/the media.
The final type of social interaction that Manski defines is preference interactions. This
occurs when other agents impact the order of preferences that an individual holds. Simultaneous
non-cooperative game theory is exemplary of this since the actions of one players affects the
utility of another player, altering the preference ordering on the alternatives in his choice set
(Manski 2000, pg. 9)

While Manski lists types of social interactions, Glaeser and Scheinkman (2001) describe
some more explicit mechanisms by which social interactions can affect individual decision
making. The first mechanism he defines is physical and learning interactions (pg. 13). An
example of a physical interaction is compatibility requirements. Windows computers are often
purchased because only they can run certain software that businesses require. Consider again
Manskis research and development example. The peer effects produced from research and
development can be bifurcated into a constraint interaction and a physical interaction. This is
because research and development both enlarges the production set of peers who are exposed to
new information (constraint interaction) and imposes compatibility constraints as a result of the
technology that an innovation may rely on (physical interaction). This is an example of why it is
important for identification to distinguish among these types of effects. Identification otherwise
may provide inaccurate explanations if the type of effect is not clearly stated.
Learning interactions are a subset of this category and are very close if not the same as
Manskis observational learning effect (Manski 2000). Simply put, it is easier to conduct an
action after watching someone else perform it. While learning definitely takes place locally
among neighbors, it can also occur among random members of a population (Ellison and
Fudenberg 1993). Another type of interaction defined by Glaeser is signaling and taste
interactions (Glaeser and Scheinkman 2001, pg. 15). This occurs when an individual possesses
the desire to resemble a specific group or other individual (Glaeser and Scheinkman 2001, pg.
15). This phenomenon can produce negative externalities. When criminality is commonplace,
stigma associated with crime is lower (Rasmussen 1996). There can, however, be positive
interactions. When employment turnover is common in an area, the stigma associated with job
loss/mobility is lower (Glaeser, Sacerdote, and Scheinkman 1996). Additionally, a taste

interaction can occur when the utility one gains from an activity increases or decreases as the
number of people engaged in that activity increases (Akerlof 1997). This resembles Manskis
constraint interaction (Manski 2000).
For purposes of this paper, I find it most useful to collapse Manskis and Glaesers
definitions into what I will refer to them as for the remainder of this paper. From now on I will
refer to Glaesers learning interactions and Manskis observational learning as observational
learning effects. I will refer to Glaesers signaling and taste interactions and Manskis preference
interactions as social utility effects. This is justified since these types of effects are only different
nominally. I exclude some effects such as constraint interactions since they are not commonly
occurring in the literature and not further mentioned in this paper.

2.2 Spatial Interactions

The spatial dimension of peer effects is of crucial importance to understand how peer effects
are distributed, what groups are interacting, and how powerful the effects are. While a basic
assumption of many models is that interactions are limited by physical distance, recently with
greater communication technology, interactions are occurring more often across neighborhoods
and cities (Conley and Topa 2002). However, distance is still important as most peer interactions
take place with people who live within five miles of each other (Wellman 1996). As will be later
discussed, the size and distance among group members will determine the strength of
interactions and the type of interactions. Within smaller groups, influence is not unidirectional,
and there exist feedback mechanisms in which two people are mutually influencing each others

actions (Krauth 2006). Whereas in larger group settings, interactions can be seen as more
unidirectional.

2.3 A Presumption Towards Skepticism

Stefano and Lissoni give several reasons to be suspicious of the concept of peer effects.
(Stefano and Lissoni 2001). It is important to recognize what a measurement of peer effects
actually means. Understanding the circumstances for peer interactions is imperative because
what might appear as a knowledge spillover may only be a result of pecuniary externalities
(Stefano and Lissoni 2001, pg. 1000). This is particularly the case in groups of people who work
together as the information exchanged may not be social but solicited. Additionally, papers that
analyze knowledge spillovers from university to firms may only be observing a flow of
information that is an established exchange that occurs due to deliberate appropriation
purposes (Stefano and Lissoni 2001, pg. 1000). Theoretically, therefore, it is better to conceive
peer effects as interactions that are not facilitated by ordinary business or financial transactions.
Rather, peer effects are socially facilitated in a more casual setting. This theoretical
understanding will aid in distinguishing between ordinary information flows and social
information flows in order to achieve accurate identification of peer effects.

3. Experimental Evidence of Peer Effects

Examining experimental field evidence of peer effects is useful for recognizing in what
contexts such interactions exist and have significant effects. I separate the discussion of field

experiments and empirical results because field experiments are directly able to avoid
identification problems. This is because field experiments directly apply treatments that measure
peer effects isolated from any endogenous variables. Empirical measurements, on the other hand,
must deal with endogeneity using specific identification techniques. Therefore, the purpose of
this section is not to survey identification methods, but to examine instances in which peer
effects are easily measurable. This evidence may suggest areas of interest for empirical research.

3.1 Retirement

One example of peer effects found using experimental procedures is in retirement decisionmaking. In a field experiment, Beshears et al. (2015) facilitate mailing of retirement saving
information to groups at different companies. A control group was mailed a generic packet of
information about retirement savings. The treatment group was mailed the same packet, plus
information about the retirement decisions of that groups coworkers. The contribution rate to
retirement savings after the exposure to the information packet was greater for the treatment
group than for the control group. The study concluded that the treatment group converged
towards conformity with decisions provided in the information packet. However, participants
who are part of labor unions surprisingly responded with lower contributions and participation.
This suggests that peer effects can have negative effects in situations when the group receiving
information has an antagonistic relationship with the sender of information. The peer effects in
this experiment most closely resemble observational learning effects and social utility effects.
The observational learning effect occurred because people considered their peers decisions as
sound advice and mimicked it. The social utility effects occur because people gain greater utility

from choosing the same retirement decisions as their peers. For example, similar retirement
decisions might cause a person to retire at the same time as her coworkers. However, this
experiment does not take separate measurements of these effects. Bursztyns experiment, which
is later discussed, conducts isolated measurements of these two effects in a similar context.
In another field experiment, Duflo and Saez (2003) set up a retirement booth promoting tax
deferred accounts at a universitys employee fair. Duflo divided control and treatment groups by
employees of different departments. Each group consisted of about 2,000 employees. In treated
departments, a random subset was mailed information of the fair. In the letter, this group was
guaranteed a small monetary incentive if they visited the booth at the employee fair. The
controlled department received no such letter. At the fair, the booth kept attendance of visitors
who did not receive a letter. Therefore, the experiment compared people from treated
departments who did not receive a letter to all the people in the untreated department. This
ensured that the monetary incentive was not counted towards influencing turnout. The treatment
group had a 21.4% attendance rate whereas the control group had less than 5% attendance. In
addition to turnout, Duflo measured the experiments effects on retirement savings in tax
deferred accounts after the fair. Duflo found that treatment members more likely to enroll in a
tax deferred account. Moreover, members of treated department who did not attend the fair were
more likely to enroll in a tax deferred account than those who did not attend from the control
group (Duflo and Saez 2003). With regards to types of interactions, the effects observed in this
experiment are social utility effects since going the fair was more desirable for people who had a
number of peers attending, but there is also an observational learning effect since people may be
going to the fair since they may be convinced by their peers that it is a good idea.

3.2 Finance

Peer effects are also found in other financial decision making contexts using experimental
evidence. Bursztyn et al. (2014) conducted a field experiment in Brazil in which a financial firm
offered a new financial asset to a pair of social companions. In the offer, the investment decision
regarding the asset of one companion was revealed to the other member of the pair. The
experiment involved a lottery to see if people who wanted to purchase the new asset were
allowed to. In this way, one member of the pair could be informed either of the companions
purchase of the asset or preference for the asset. This design distinguishes between social utility
effects and observational learning effects. 42% of a control group who was not informed of the
other members decision chose to purchase the asset. 71% of the treatment group informed of
their partners preference for the asset (who werent able to purchase it because of the lottery),
purchased the asset. Finally, 93% of those whose partner both had a preference and purchased
the asset, purchased the asset. The first condition illustrates observational learning effects as one
partner observed the preference of the other and was impacted knowledge of the others
preferences. The second condition illustrates both observational learning and social utility since a
person may gain utility from an asset if a social companion also possesses that asset. This further
demonstrates how a single identification of peer effects can be bifurcated into separate
mechanisms and offers an example of how an experiment can set up measuring the effects
separately.

3.3 Consumption

3.31 Energy Consumption

Peer effects are also found in energy consumption decisions using a field experiment similar
to the previous example. Ayres, Raseman, and Shih (2012) conducted a field experiment
involving 85,000 households and exposed them to the energy consumption choices of their
neighbors to see what peer effects, if any, there were. This experiment measures an observational
learning effect and a social utility effect. To implement the experiment, a treatment group of
households was sent an energy report that included a comparison of that households
consumption to neighbors and efficient neighbors. The study found a significant drop in the
electricity consumption of treatment households relative to control households which
strengthened in magnitude over the course of a few months (Ayres, Raseman, and Shih 2012, pg.
7). Despite a very similar design, this experiment provides evidence of peer effects distinguished
from the previous examples in a few ways. Rather than defining neighbors using social distances
and workplaces, this study defined neighbors purely in terms of physical proximity and still
found significant results. This suggests that even without clearly defined social ties to neighbors,
exposure information of what people nearby think seems to still have an impact of the decisions
of households. This has some policy implications in that providing information of neighbors
decision making can create positive externalities tailored to specific goal simply by mailing
information. One must note, however, that field experiments guarantee that peers are exposed to
information whereas empirical measurement assumes that proximity facilitates interaction.
Another interesting observation from this experiment is that households with lower house values

generated more saving in the treatment group than more expensive houses. This points to that
some group can be impacted to a greater degree by peer effects.

3.32 Leisure consumption

Godinho de Matos, Ferreira, and Belo (2015) examine peer effects experimentally in
context of pricing decision and different levels of consumption, and looks at how word of
mouth can act as a multiplier on product promotion and discounts (pg. 2). The experiment
used a unique technique for defining social proximity by tracing phone records to create maps of
social ties. Then the experiment created a treatment group in which households were offered a
discount on a movie on demand over three months while a control group had the same movie
available at the regular price. They concluded, using the social map in the area using call records,
that 2.8% of the sales of the movie examined in the experiment was impacted by word of mouth
(after effects were isolated from the price discount effect). This was measured by observing the
change in consumption of households that were neither in treatment or control group. If these
households experienced change in behavior and were socially tied to the treatment group, then
this is of evidence of peer effects generated by the treatment group. This experiment has
businesses implications since the traditional expectation of a loss of revenue associated with
price promotions may not be negative if the multiplier effect of word of mouth is positive enough
to offset it. The use of call records was a novel way to define social ties that can also be utilized
in empirical measurements. The experiment also showed that households have a clear impact on
consumption decisions of their peers. This can be seen as an example of social utility effects,
since utility might be gained by desiring to resemble ones peers since they can derive utility

from conversing with their peers about the movie they both watched. However, these effects
could be considered observational learning since one may only listen to her peers because it may
lead her to watch better movies.

3.33 Food Consumption

Another field experiment found evidence of observational learning that takes place across
individuals who do not know each other. The experiment was conducted at a Beijing restaurant,
and sought to measure how exposure to peer preferences of food dishes changed the patterns of
consumption (Cai, Chen, and Fang 2009). In one treatment condition, before being sat at tables,
parties were exposed to an informational display which showed the top five dishes sold the
previous week. An additional treatment was administered to some parties. In this second
treatment group, parties saw a list of the top dishes sold the previous week, but this information
was provided on the table rather than at an informational booth. However, this list only included
3 of the actual most popular dishes and 2 randomly selected ones. This was done to distinguish
between the observational learning effect and the saliency effect (Cai, Chen and Fang 2009,
pg. 2-3). The saliency effect is the extent to which dishes were chosen merely because those
dishes are better than other options. Finally, a post-eating survey was administered that collected
information regarding about a partys frequency of dining at the restaurant and the partys dining
experience. This allowed the experiment to look at how frequency affected the potency of peer
effects. The results showed that the demand for the dishes increased between 13 and 18 percent
on average when the rankings were revealed as compared to when they were not. Additionally,
the analysis found that the saliency effect was statistically insignificant (Cai 2009, pg. 17). Not

surprisingly, the study found that frequent customers were less likely to purchase one of the five
dishes. This is presumably because they had already established certain preferences whereas less
frequent visitors had no previously established preference. An interesting part of this experiment
is that the costumers were not in direct communication with one another, and therefore, were
only treated by the revelation of best sold dishes the previous week. This shows that individuals
value the preferences of others even when they are not certain of who their peers disclosing the
information are. Although, these effects might resemble social utility effects they are not this
type of interaction. There is no utility gained from a desire to resemble strangers who prefer
certain dishes. Rather, this is an observational learning effect since people conform to strangers
in hopes of eating a better meal. The study also suggests that people without knowledge or
preferences about a product are more likely to be susceptible to peer effects as they have little or
no previous knowledge about the product.

3.4 Summary

As the next section will discuss, even the strictest adherence to identification techniques does
not guarantee evidence of peer effects. Experimental field evidence is therefore vital to
understand what sort of situations generate peer effects, what mechanisms facilitate peer effects,
and what sort of variables affect the potency of peer effects. Understanding these contexts will
aid in interpreting ambiguous empirical results. This review has found that peer effects exist in 1)
retirement savings decisions, 2) financial savings, 3) energy consumption, 4) consumption of
leisure goods, and 5) consumption of food. Field evidence suggests peer effects exist through 1)
observational learning effects and 2) social utility effects. Finally, several variables affect the

potency of peer effects, such as: 1) the relationship to the information provider, 2) group size, 3)
income level/ability to make changes to consumption, 4) how well established pre-existing
preferences for a product are, and 5) how familiar the peers are with one another.

4. Econometric Identification of Peer Effects

While field experiments of peer effects offer evidence without use of identification
techniques, it only opens a narrow window to observe peer effects in instances in which large
scale intervention is undertaken. Identification techniques in empirical situations are pivotal to
observe peer effects without experimental intervention. A strategy of econometric identification
is necessary to analyze different contexts of peer effects empirically using collections of
untreated data.
There are a number of problems that identification of peer effects faces. The reflection
problem occurs because there are feedback mechanisms of social influence, meaning there is
endogeneity. This endogeneity exists because the peer effect that the group exerts on an
individual may be correlated with the influence that individual exerts on the group. The example
in the introduction illustrated this. Solving the reflection problem involves correctly interpreting
the extent to which a group median is actually responsible for influencing individuals. This
requires controlling for how that individual effects the group. Spatial measurements of peer
effects also introduce new identification problems such as spatial error autocorrelation. This
section shows a number of approaches to overcome these problems. The reflection problem can
be overcome by the observable trait identification technique, the time lagging approach, or

partial-population identification. Spatial error autocorrelation can be eliminated using partial

population identification or determining that the error is insignificant.

4.1 The Reflection Problem

When viewing peer interactions from an empirical perspective, there are three categories of
hypotheses into which interactions can be classified. Endogenous interactions occur when
propensity of a person to behave in some way varies with the behavior of the group (Manski
2000, 23). Contextual interactions occur when a persons behavior varies with exogenous
characteristics of the group (Manski 2000, pg. 23). Finally, correlated effects occur when
people within a group behave similarly because they share the same individual characteristics or
environment.
Despite peer effects importance, they are tricky to identify empirically. The seminal paper
that lays out the main problems of peer effect identification is Manski (1993). The largest
problem of econometric identification is what Manski calls the reflection problem (also the
simultaneity problem) (Manski 1993, 532). This problem can be summed as that data do not
distinguish between endogenous interactions, exogenous interactions, and correlated effects
(Manski 1993). Additionally, peer effects are not unidirectional but multidirectional as an
individual is simultaneously influencing others while being influenced herself. This problem also
entails determining equilibria correctly since every individual exerts social influence on others in
a feedback like manner. In this context, an equilibrium is a point which reflects observed
behavior as a result of social factors encouraging a person to act a certain way and the influence
that person exerts on other people to act a certain way. In order to correctly achieve identification

in these conditions, one must distinguish between group characteristics that generate common
individual behavior and similar individual behaviors that generate a common group behavior.
The existence of this problem leads Manski to conclude that identification is not possible unless
the researcher has prior information specifying the composition of reference groups (Manski
1993, 532). By possessing information of the group, one is able to distinguish between
exogenous and endogenous interactions by observing variance of individual characteristics
relative to common group characteristics (Manski 1993). This is what I call the observable trait
identification technique. Consider again the binary choice property development example that I
used in the introduction. If an undeveloped property is used for farming but the surrounding
undeveloped properties have no use at all, then one could argue that influence of the farms
status on the surrounding properties is greater than the surrounding properties statuses influence
on the farm. This is because the opportunity cost of keeping ones land undeveloped is higher for
the undeveloped lands with no use than is the undeveloped land with farming use. Observing
characteristics of properties and relating it to a behavior of interest allows one to distinguish
between the two effects of the reflection problem.
However, Manksi notes a few other ways to achieve identification. Time lagging to account
for shifts of equilibrium is a solution if one knows the appropriate length of time such a
transition takes (Manski 1993). How would time lag solve the reflection problem in the land-use
example? Consider this example that takes place over four years. In year one, all properties in a
vicinity are undeveloped. In year two, the properties remain undeveloped. In year three a single
property owner decides to develop. In year four half of the remaining properties decide to
develop. What can one conclude from this scenario? Since there was no change in surrounding
properties from year one to year two, the cause of the single property deciding to develop in year

three was due to external factors and not due to influence from the surrounding properties.
However, in year four the properties decision to develop can be attributed to the influence of the
single propertys decision to develop since they wouldnt have developed otherwise as observed
in between years one and two. Thus, this example clarifies the distinction between individual
influence on group, and group influence on individuals. The group influence on the individual
property that chose to develop in year three was insignificant, but the influence of that propertys
status on the development decisions of the other properties was significant. Note that while this
analysis does overcome the reflection problem, it lends itself to a correlated effects problem.
This is because the onset of the new development of lands could be merely correlated with
external factors. This is another problem associated with identification called the correlated
effects problem. Papers that I discuss such as Irwin and Bockstael (2002) will encounter this
problem. This must be addressed through assumptions or incorporation of the previous solution
of observing group characteristics. The observable trait identification technique would resolve
this problem since the observed characteristics would control for any common factors that drive
decision making.
Another way to get around the reflection problem is if one knows the nonlinear function by
which group behavior and individual behavior varies. Using one of these approaches resolves the
reflection problem by distinguishing between endogenous, exogenous, and correlated
interactions. With observable group traits, one can differentiate between individual traits that
vary with group behavior and group traits that vary with individual behavior. With these
measurements, endogeneity is no longer a problem since individual characteristics are not
correlated with the error term. This strategy is novel. Manski (2000) notes that there was very
little, if no, truly causal evidence of peer effects prior to 2000. This is because previous studies

were sociological in nature and looked primarily at descriptive data of neighborhoods and drew
conclusions in contexts of race, crime, income, and education by using assumptions of group
composition. Even with one of Manskis proposed identification techniques, he warns that
identification is only as credible as the identifying assumptions imposed (Manski 2000, 17).
Bayer and Timmins (2007) take Manskis identification strategy a step further and argues
that the observable trait identification technique by itself is not enough and may be responsible
for skewing results. This is because such a model only accounts for how certain attributes are
valued at that area instead of how those attributes are valued at other locations. In context of
investment decisions among different properties, an observable characteristic of a property
should not only be valued relative to properties close to it, but also valued based on the the
characteristics of other possible locations thought of as alternative choices. Bayer argues that
lack of this consideration can result in overestimation of peer effects. Therefore, appropriate
measurement would involve a variable correlated with fraction of the individuals that selects
a given location, but . is not correlated with the unobserved fixed attributes of that location
(Bayer and Timmins 2007, pg. 4).
Moffit (2001) adds to this discussion by suggesting some specific techniques that further
aid identifying peer effects. Natural events that 1) change group membership, 2) alter group
behavior or 3) change social norms are ideal candidates for identifying peer effects empirically
as they capture movement from one equilibrium to another. This sort of identification feeds into
Manskis conception of time lagging variables in order to account for how long it takes for the
equilibrium to shift to a new point. Therefore, knowing the speed of the adjustment is important.
Additionally, this identification assumes that fundamentals of individuals in the population do
not change with the event. Additionally, the change may be endogenous such that putting a new

member into a group causes the new member to leave or change behavior to adjust for her new
situation, shifting back to an old equilibrium after the initial shock. A final problem is that the
equilibrium shift may overcompensate as a result of old members leaving as a reaction to the
change in group membership. Because of these problems, it is recommended by Moffit to adopt
strategies of identification that involve altering group behavior rather than changing group
membership, because the former avoids most of these problems. Experimental papers such as
Dulfo employs such a strategy by introducing a subset of a population to information and then
observing the change in equilibrium. Empirical identification can capitalize on the same
technique by using some natural variable such as mass media exposure or educational campaigns
(Moffit 2001).
A particularly important application of the time lagged approach to identification is
conducted by Irwin and Bockstael in context of land use (Irwin and Bockstael 2002). They
surveyed whether land-use (residential or commercial) patterns are influenced peer effects. In
their mode, they assume profit-maximization agents faced with a discrete choice of converting to
residential use or keeping land undeveloped. Their hypothesis was that the cost of keeping
undeveloped land is lower when surrounded by undeveloped land and higher when surrounded
by residential land. They tackled Manskis reflection problem by proposing that the interaction is
not simultaneous and rather the relationship operates as stimulus and response since land
conversion requires time. Although this is a valid approach to identification, it must be noted that
they did not account for outside explanatory variables which could alternatively explain the
changes in development patterns. Irwin (2002) adds to this approach in which she uses a vector
of location attributes to identify property values though a hedonic pricing model. A hedonic
pricing model is a model that captures different attributes of a property and regresses it to

determine how each attribute affects the value of the property. However, using a hedonic pricing
model opens the door to new identification issues such as spatial error autocorrelation. Spatial
error autocorrelation is a result of a correlation among a set of characteristics of locations in
proximity. Therefore, by this analysis, the magnitude of peer effects may be artificially higher
than actual value. Spatial error autocorrelation means that a set of observable characteristics
(such as in Manksis first identification solution) is correlated with the error term since differing
unobservables at these locations are correlated with those characteristics. Irwin implements no
strategy to overcome spatial error autocorrelation but merely notes that the error is not significant
enough to change the direction of the relationship although it might affect the magnitude and
accuracy of the measurement. Carrin-Flores and Irwin (2010) draw upon a combination of this
hedonic pricing model and Moffits strategies of identification to eliminate not only the
reflection problem but also spatial autocorrelation (Carrin-Flores and Irwin 2010). They do this
by implementing Moffits strategy in which part of the population is affected by some event that
alters the populations preferences/behavior. This is called partial-population identification. By
incorporating PPI, they were able to overcome spatial error autocorrelation such that the error
became insignificant. Interestingly, when conducting the identification using the full population,
the spatial error outweighs any statistical significance but when partial-population identification
was implemented, the error was insignificant (Flores and Irwin 2010). Carrin-Flores and Irwin
conclude by arguing that incorporating natural experimental techniques into empirical
measurement provides much clearer evidence on peer effects than empirical measurement alone.
Finally, there are a few other approaches to overcome the reflection problem that can be
noted and useful. Graham uses the observation that if unobservable group characteristics are
random, one can identify group attributes by accounting for randomness in variance structures

(Graham 2008, Durlauf and Ioannides 2010, Conley and Topa 2007). By summing the variance
of group-level heterogeneity, between-group variance of individual heterogeneity one
can obtain the error component that acts as a control for identifying peer effects without having
to undergo identification of specific attributes as Manski suggests (Graham 2008, pg. 644). Once
this error is calculated and accounted for, social influence can be calculated. Graham applies this
identification to schools where he observes heterogeneity in teacher quality and peer quality
(Graham 2008, pg. 645). This type of identification is only applicable in specific cases when one
is confident in the heterogeneity sufficiently exists in the group. Solon, Page, and Duncan (2000)
take a similar approach that relies on random assignment of public housing to generate
correlations between unrelated neighbors which are used as a control to identify suspected
socially related households (pg.1).

4.2 Spatial identification

In identifying peer effects in land use, Irwin and Bockstael employed a model of
statistical mechanics to capture how different agents (or particles) interact in proximity to form
macro-level patterns. Conley and Topa (2007) provide an example of such a model of statistical
mechanics in context of peer effects. They spatially regress correlations which reveal a
probabilistic relationships of the social interactions of individuals as a function of distance. They
find statistically significant degree of spatial dependence in the distribution of raw
unemployment rates which are able to overcome spatial autocorrelation (Conley and Topa
2007, pg.305). Econometrically, they defines each observation in Euclidean space and assigns it
a random variable (Conley and Topa 2007, pg. 315). If the distance between two points is

small, then the random variable between the points is more dependent and if the distance is
larger then the random variable is more independent. Specifically, Conley defines covariance as
a function of distance. This model is therefore able to incorporate observable attributes as
Manski suggests but does so in a spatial manner. Proximity can also be defined in a number of
ways. It could be defined as geographic distance, time traveled distance, socio-demographics,
and other indicators that suggest social interactions. Although telecommunications make
physical distances less important for social connections, Wellman finds evidence that people
who live less than five miles apart undergo a significant amount interaction with their neighbors.
This type of statistical mechanics model is deployed in Irwin and Bockstael as well as all later
papers that analyze social interactions spatially such as Conley and Topa (2002) and Glaeser and
Scheinkman (2001).

4.3 Summary

This section has shown that the main problem with econometric identification is the
reflection problem, which consists of distinguishing between different types of
hypotheses/variables of peer effects. There are a number of approaches overcoming this
problem: 1) observable trait identification technique, 2) time lagging approach, and 3) partial
population identification. The main technique for spatial mapping of peer effects relies on
statistic mechanics; examples of this are found in Irwin and Bockstael (2002).
There exist tradeoffs among using different techniques of identification, however, many of
these approaches can be combined. To find spatial correlations of peer effects for local groups,
an optimal approach might involve a statistical mechanical model that involves both observable

group characteristics and partial-population identification. This approach would overcome both
the reflection problem and spatial autocorrelation while providing evidence of peer effects and
showing how those effects are spatial distributed. Carrin-Flores and Irwin show that any
identification technique can be strengthened by adding partial population identification as
designed by Moffit if natural conditions are conducive. However, a combination of identification
techniques can lead to results which are only somewhat suggestive of peer effects. The more
applicable identification strategies are to specific contexts, the more accurate the measurements
of peer effects will be.

5. Empirical Results

Empirical measurement of peer effects offers examples of how identification techniques are
applied to certain circumstances. Additionally, knowledge of identification techniques can lend a
critical perspective of empirical results as they a studys results may not be clean evidence of
peer effects if identification techniques are applied improperly or neglected. Measured correctly,
empirical results reveal valuable information about social interactions. Examining empirical
examples offers insights into linkages between contexts surrounding peer effects and
identification techniques.

5.1 Land Use/Property Value

Irwin (2002) offers a solid example of an empirical study and was briefly discussed in the
previous section. Drawing from her previous work on land use social interactions, Irwin expands

her approach to residential property in Maryland using a hedonic pricing model. She notes that
the reflection problem exists since open space not only affects the value of residential property
but also the value of the residential property affects the decision to keep the open land
undeveloped. Unlike her previous paper that relied on time lag to solve the reflection problem,
the hedonic model in this paper is used to over come the reflection problem. However, Irwin
notes that spatial error autocorrelation will exist in this model but is ignored as it is offset by the
large number of observations used to estimate the model (Irwin 2002, pg. 7). She additionally
accounts for neighborhood variables in order to control for variation in other aspects of the
locations. She ultimately finds that a one-acre increase in the surrounding area is like to increase
the property value by one percent. This is an example of a paper that follows the literature and
incorporates a number of the existing techniques well.
Robalino and Pfaff (2012) is another example of a proper extension of the empirical
framework discussed in the previous section of this paper. He measures the effects peers have on
deforestation decisions in Costa Rica. Ronalino use the slope surrounding land as an exogenous
variable in order to account for the reflection and correlated effects problems since the impact of
slopes on deforestation decision is insulated from any type of correlated effect. This approach is
someone different than others since it proceeds by defining one variable which is assumed to be
exogenous instead of using multiple characteristics and deciphering to what degree those
characteristics are exogenous or endogenous. They conclude finding positive spatial interactions
that occur spatially with very low spatial error autocorrelation.
Rosiers, Dub, and Thriault (2011) take a unique approach to peer effects and combines
Manskis reflection problem solving approach with the hedonic pricing model in order to
account for how social interactions influences the values of property. This is interesting because

it is similar to Irwins approach who noted that spatial error auto correlation may arise as a result
of using a hedonic pricing model. Rosiers additionally adds to this model a time lag similar to
Irwin and Bockstael. With this, Rosiers concludes that social interactions affect the
determination of property values after employing an adaptation of Manskis model onto the
hedonic pricing models. Rosiers also notes that the coefficient of peer effects shrinks as the
number of sub-housing markets are increased. This is a confirmation of the theoretical prediction
made by Krauth. This paper is also an interesting combination of Irwins hedonic pricing model
with the time lag model of her previous paper. This demonstrates that a combination of
identification techniques can be deployed to arrive at results.

5.2 Knowledge Theory of Entrepreneurship

The knowledge theory of entrepreneurship suggests that businesses fare better when they
have access to more information, creating access to new opportunities that they can exploit that
other firms may not have access to. Acs et al. (2009) set out to show that this informational
advantage can be explained exogenously by social interactions. However, in order to test this
theory, one should ideally show that these interactions occur outside normal business
transactions otherwise the results would be only endogenous, as Stefano and Lissoni in the first
section of this paper suggested. (Stefano and Lissoni 2001). However, this paper does not do so
and the paper does not sufficiently distinguish between endogenous and exogenous variables.
The paper relies on dependent variables such as patents the company holds, value added in the
previous year, and population of company that lives in urban cities. These variables do not
distinguish whether those values are correlated with business growth solely because of

information exchanges. Patents may be correlated with business growth merely because patents
provide monopoly over certain products and may have been purchased. Even if patents were a
result of informational exchanges, they still are paid for either by purchasing the patent or
through paying R&D staff. While this involves information exchanges, it does not involve
informational exchanges outside the tradition mode of production and paid labor. They justify
the urban city variable because information flows are much denser in cities, but this a type of
broad assumption that Manski criticizes that sociological evidence relied heavily on prior to the
2000s (Acs et al. 2009, pg. 20). Additionally, this assumption is not justified. Relying on this
mode for evidence of peer effects delegitimizes the strength of Acss results of peer effects. Thus
is an example of a paper that uses inexact, basic, and biased methods to justify generalized
theory in a fashion that is not formal or accurate. Simply put, the evidence found is more likely
exogenous than endogenous. Despite this, the article is widely cited.

5.3 Retirement

Chalmers, Johnson, and Reuter (2014) look at retirement peer effects in an empirical setting
which mirrors the experimental evidence on retirement in the field experiment section of this
paper. Analyzing employment data from Oregon, Chalmers observes that coworkers are more
likely to retire when their coworkers retire. Interestingly, rather than deduce peer effects impact
on retirement decision, Chalmers works backwards and seeks to prove that peer effects are
driving this already observed correlation. Chalmers indicates that Manskis reflection problem
may exist in this context since there are many feedback forces acting on agents and thus he
distinguishes between correlated effects, exogenous effects, and endogenous effects. In order to

overcome the the reflection problem and correlated effects problem they adopt Manskis
observable characteristic identification. To rule out exogenous effects, cases where factors
related to the group other than peer effects that drive similar investment decision, they include
variables such as employer and county dates. They watchfully conclude that that coworkers do
influence retirement decisions. This is example of a well thought empirical design that follows
the econometric literature and employs valid casual techniques, but is not able to make as strong
a conclusion as some experimental paper analyzing retirement were.

5.4 Tax Credits

Chetty, Friedman, and Saez (2012) take a very different approach to peer effects than the
previous papers. Their paper attempts to identify how differences in knowledge across
neighborhoods affect the use of the earned income tax credit. There are many assumptions
employed in this paper that at first glance may impose limitation on the results, but the context in
which they are described make them credible. First, is that since they lack knowledge about
individual perceptions of the EITC, they measure knowledge in terms of how close any
individual got to maximizing their EITC refunds. This assumption directly attributes any
deficiency in tax refund maximization to knowledge, and will definitely determine how they
interpret the findings. They then proceed by showing that individuals with lack of knowledge
about EITC are sharp bunch[ed] in neighborhoods (Chetty, Friedman, and Saez 2012, pg 2).
They further assume that low bunching neighborhoods do not believe the EITC affects their
marginal tax rate. To justify this assumption, they show that spatial heterogeneity is determined
by differences in knowledge about the EITC schedule. They observe that people move from low

bunching to high bunching neighborhoods are more likely to gain higher EITC returns. This is a
valid technique employed as it follows Moffits strategy in which new members are added to a
group, but this opens up doors to other identification problems previously as discussed by Moffit.
In this context, however, the application seems reasonable as the addition of new members
wouldnt change the fundamentals of other with regards to tax returns or cause members of the
new group to leave. Additionally, the affect of moving to a high bunching neighborhood seems
to be asymmetric such that Manskis reflection problem may not be present in this situation
although Chetty does not make this observation explicitly. It makes sense that there is no
feedback mechanism as being around people who received a lower tax return is not likely to
influence someone to lower her tax returns. This is furthered confirmed Chettys observation that
the tax returns of people who move to a low bunching area from a high bunching are not
decreased. This provides a novel instance of peer effects that seems to avoid the reflection
problem altogether. This paper may be ignorant of the formalized econometric techniques
surrounding the explicit social interactions literature, but the assumptions and identification
employed here are reasonable and are similar to approaches previously discussed. This paper
opens up a discussion of asymmetric information exchange which circumvents the reflection
problem in certain circumstances. Otherwise bunching by it self is insufficient evidence for peer
effects (Bayer and Timmins 2007)

5.5 Social Donations

A final example of an empirical measurement of peer effect looks at evidence contradicting a

traditional model of social donations (Zhang and Zhu 2010). Theoretical models suggest that

willingness to donate is inversely related to group size of the number of people donating. This is
because supposedly each individuals marginal utility from contributing if she knows her
contribution to the public good is smaller with a larger group of people donating. Looking at
Chinese Wikipedia donations with special focus on the 2005 block creates a natural treatment of
lessening the group size of contributor and allows the study to get around endogeneity. The study
focuses on the block that lasted one year starting in 2005. To start, they identified the
contributors unaffected by the block by detecting keyboard characters and noting if someone
joined before the block and contributed during the blocked period. Contrary to models, the study
found that when the group size was reduced the contributions from the remaining population
decreased by 41%. This study is significant because it provides a very unique approach to
identification of peer effects using a policy as a natural treatment and way around endogeneity.
Secondly, it provides some insight on the how group size affects the impact of peer effects and
suggests that changes in group size affect how potent peer effects are and that with regards to
societal contributions peer effects are stronger in larger groups contrary to theoretical claims.

6. Conclusion

This paper has surveyed literature on peer effects in a number of circumstances in order to
determine the best strategies of identification. Theoretical concepts describe the two main types
of peer effects categories in the literature: observational learning effects and social utility effects.
It may be useful in identification to distinguish between these two effects as they can be seen as
different mechanisms that hold different policy implications. Field experiments found evidence
of peer effects in retirement, financial, energy, and consumption decisions. This is useful for

identification because it provides clues for what sort of situations peer effects can be found in
empirically. The identification section of this paper most directly addresses the research question
by discussing some specific techniques that can be used to identify peer effects empirically. The
most significant problem with identification is the reflection problem in which feedback
mechanisms distort data from distinguishing between endogenous, exogenous, and correlated
interactions. There are a number of techniques to overcome this problem such as finding data of
observable group traits, controlling for time lag of variables, or observing random heterogeneity.
Additionally, the partial population identification technique described by Moffit and
operationalized by Irwin is extremely useful for more accurate results. Empirical results are
useful in understanding identification techniques because they often use a combination of the
techniques described in the econometric section and apply it to a number a variety of situations.
The most useful lesson taken from this section is that combining identification strategies to suit
specific contexts is the best way to attain better observation of peer effects.

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