Estimating Discrete-Continuous Choice Models: The Endogenous Grid Method with Taste Shocks

35 Pages Posted: 28 Nov 2015

See all articles by Fedor Iskhakov

Fedor Iskhakov

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR)

Thomas Jørgensen

University of Copenhagen

John Rust

Department of Economics, Georgetown University

Bertel Schjerning

University of Copenhagen - Department of Economics

Date Written: November 26, 2015

Abstract

We present a fast and accurate computational method for solving and estimating a class of dynamic programming models with discrete and continuous choice variables. The solution method we develop for structural estimation extends the endogenous gridpoint method (EGM) to discrete-continuous (DC) problems. Discrete choices can lead to kinks in the value functions and discontinuities in the optimal policy rules, greatly complicating the solution of the model. We show how these problems are ameliorated in the presence of additive choice-specific IID extreme value taste shocks. We present Monte Carlo experiments that demonstrate the reliability and efficiency of the DC-EGM and the associated Maximum Likelihood estimator for structural estimation of a life cycle model of consumption with discrete retirement decisions.

Keywords: Structural estimation, lifecycle model, discrete and continuous choice, retirement choice, endogenous gridpoint method, nested xed point algorithm, extreme value taste shocks, smoothed max function

JEL Classification: C13, C63, D91

Suggested Citation

Iskhakov, Fedor and Jørgensen, Thomas and Rust, John and Schjerning, Bertel, Estimating Discrete-Continuous Choice Models: The Endogenous Grid Method with Taste Shocks (November 26, 2015). Available at SSRN: https://ssrn.com/abstract=2696079

Fedor Iskhakov (Contact Author)

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

Level 6 Central Lobby (enter via East Lobby)
Australian School of Business Building
Sydney, New South Wales NSW 2052
Australia

Thomas Jørgensen

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

John Rust

Department of Economics, Georgetown University ( email )

Washington, DC 20057
United States
1-202-687-6806 (Phone)
1-202-687-6102 (Fax)

Bertel Schjerning

University of Copenhagen - Department of Economics ( email )

Øster Farimagsgade 5
Bygning 26
1353 Copenhagen K.
Denmark

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