An Instrumental Variable Approach to Dynamic Models

56 Pages Posted: 6 Aug 2020 Last revised: 2 Feb 2022

See all articles by Steven Berry

Steven Berry

Yale University - Department of Economics; National Bureau of Economic Research (NBER); Yale University - Cowles Foundation

Giovanni Compiani

University of Chicago Booth School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: August 4, 2020

Abstract

We present a new class of methods for identification and inference in dynamic
models with serially correlated unobservables, which typically imply that state variables
are econometrically endogenous. In the context of Industrial Organization, these state
variables often reflect econometrically endogenous market structure. We propose the
use of Generalized Instrument Variables methods to identify those dynamic policy
functions that are consistent with instrumental variable (IV) restrictions. Extending
popular “two-step” methods, these policy functions then identify a set of structural
parameters that are consistent with the dynamic model, the IV restrictions and the
data. We provide computed illustrations to both single-agent and oligopoly examples.
We also present a simple empirical analysis that, among other things, supports the
counterfactual study of an environmental policy entailing an increase in sunk costs.

Suggested Citation

Berry, Steven T. and Compiani, Giovanni, An Instrumental Variable Approach to Dynamic Models (August 4, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-106, Available at SSRN: https://ssrn.com/abstract=3668248 or http://dx.doi.org/10.2139/ssrn.3668248

Steven T. Berry

Yale University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
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Giovanni Compiani (Contact Author)

University of Chicago Booth School of Business ( email )

Chicago, IL
United States

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