Dynamic Decisions Under Subjective Expectations: A Structural Analysis
CAEPR WORKING PAPER 2018-001
55 Pages Posted: 22 Feb 2018
Date Written: January 2018
his paper studies dynamic discrete choices by relaxing the assumption of rational expectations. That is, agents’ subjective expectations about the state transition are unknown and allowed to diﬀer from their objectively estimable counterparts. We show that agents’ subjective expectations and preferences can be identiﬁed and estimated from the observed conditional choice probabilities in both ﬁnite and inﬁnite horizon cases. Our identiﬁcation of subjective expectations is nonparametric and can be expressed as a closed-form function of the observed conditional choice prob-abilities. We estimate the model primitives using maximum likelihood estimation and illustrate the good performance of estimators using Monte Carlo experiments. We apply our model to Panel Study of Income Dynamics (PSID) data and analyze women’s labor participation. We ﬁnd systematic diﬀerences between agents’ subjective expectations about their income transition from those under rational expectations. A counterfactual analysis suggests that women with low and medium incomes would increase the probability of working under rational expectations, and that the probability would decrease for women with high income.
Keywords: Dynamic discrete choice models, subjective expectations, rational expectations, nonparametric identiﬁcation, estimation.
Suggested Citation: Suggested Citation