Testing the validity of a demand model: An operations perspective

Testing the validity of a demand model: An operations perspective

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Article ID: iaor20101110
Volume: 12
Issue: 1
Start Page Number: 162
End Page Number: 183
Publication Date: Dec 2010
Journal: Manufacturing & Service Operations Management
Authors: , ,
Keywords: validation
Abstract:

The fields of statistics and econometrics have developed powerful methods for testing the validity (specification) of a model based on its fit to underlying data. Unlike statisticians, managers are typically more interested in the performance of a decision rather than the statistical validity of the underlying model. We propose a framework and a statistical test that incorporate decision performance into a measure of statistical validity. Under general conditions on the objective function, asymptotic behavior of our test admits a sharp and simple characterization. We develop our approach in a revenue management setting and apply the test to a data set used to optimize prices for consumer loans. We show that traditional model-based goodness-of-fit tests may consistently reject simple parametric models of consumer response (e.g., the ubiquitous logit model), while at the same time these models may ‘pass’ the proposed performance-based test. Such situations arise when decisions derived from a postulated (and possibly incorrect) model generate results that cannot be distinguished statistically from the best achievable performance–i.e., when demand relationships are fully known.

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