Identification in a model of sorting with social externalities and the causes of urban segregation

This paper discusses nonparametric identification in a model of sorting in which location choices depend on the location choices of other agents as well as prices and exogenous location characteristics. In this model, demand slopes and hence preferences are not identifiable without further restrictions because of the absence of independent variation of endogenous composition and exogenous location characteristics. Several solutions of this problem are presented and applied to data on neighborhoods in US cities. These solutions use exclusion restrictions, based on either subgroup demand shifters, the spatial structure of externalities, or the dynamics of prices and composition in response to an amenity shock. The empirical results consistently suggest the presence of strong social externalities, that is a dependence of location choices on neighborhood composition.