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Is Econometrics Useful for Private Policy Making? A Case Study of Replacement Policy at an Auto Rental Company

By Sungjin Cho and John Rust


Abstract: The goal of this paper is to illustrate the potential usefulness of econometrics as a tool to assist private policy makers. We provide a case study and detailed econometric analysis of the automobile replacement policy adopted by a large car rental company. Unlike public policy making — where the benefits from using econometric models and “science-based ” approaches to policy making are hard to quantify because the outcomes of interest are typically subjective quantities such as “social welfare ” — in the case of firms there is an objective, easily quantifiable criterion for judging whether policy A is better than policy B: profits. We introduce and estimate an econometric model of the rental histories of individual cars in the company’s fleet. Via stochastic simulations, we show that the model provides a good approximation to the company’s actual operations. In particular, the econometric model is able to reproduce the extraordinarily high rates of return that the company obtains on its rental cars, with average internal rates of return between purchase and sale of approximately 50%. However, the econometric model can simulate outcomes under a range of counterfactual vehicle replacement policies. We use the econometric model to simulate the profitability of an alternative replacement policy under pessimistic assumptions about the rate maintenance costs would increase and rental rates would have to be decreased if the company were to keep its rental cars longer than it does under the status quo. Depending on th

Topics: automobile rental/leasing, duration models, semi Markov processes, optimal replacement policy, optimal stopping problem, dynamic programming, policy evaluation JEL classification, C13-15
Year: 2007
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