An Instrumental Variable Approach to Dynamic Models

55 Pages Posted: 31 Aug 2020 Last revised: 11 Mar 2024

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

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Date Written: August 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 2020). NBER Working Paper No. w27756, Available at SSRN: https://ssrn.com/abstract=3683640

Steven T. Berry (Contact Author)

Yale University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Yale University - Cowles Foundation

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Giovanni Compiani

University of Chicago Booth School of Business ( email )

Chicago, IL
United States

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