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

Listed author(s):
  • Fedor Iskhakov

    (ARC Centre of Excellence in Population Ageing Research, University New South Wales)

  • Thomas Høgholm Jørgensen

    (Department of Economics, University of Copenhagen)

  • John Rust

    (Department of Economics, Georgetown University)

  • Bertel Schjerning

    (Department of Economics, University of Copenhagen)

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-speci c IID extreme value taste shocks. We present Monte Carlo experiments that demonstrate the reliability and eciency of the DC-EGM and the associated Maximum Likelihood estimator for structural estimation of a life cycle model of consumption with discrete retirement decisions.

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File URL: http://www.econ.ku.dk/english/research/publications/wp/dp_2015/1519.pdf
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Paper provided by University of Copenhagen. Department of Economics in its series Discussion Papers with number 15-19.

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Length: 35 pages
Date of creation: 27 Nov 2015
Handle: RePEc:kud:kuiedp:1519
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  1. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September.
  2. Jérôme Adda & Christian Dustmann & Katrien Stevens, 2017. "The Career Costs of Children," Journal of Political Economy, University of Chicago Press, vol. 125(2), pages 293-337.
  3. Iskhakov, Fedor, 2015. "Multidimensional endogenous gridpoint method: Solving triangular dynamic stochastic optimization problems without root-finding operations," Economics Letters, Elsevier, vol. 135(C), pages 72-76.
  4. Giulio Fella, 2014. "A generalized endogenous grid method for non-smooth and non-concave problems," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(2), pages 329-344, April.
  5. Andrew Clausen & Carlo Strub, 2012. "Envelope theorems for non-smooth and non-concave optimization," ECON - Working Papers 062, Department of Economics - University of Zurich.
  6. Clausen, Andrew & Strub, Carlo, 2013. "A General and Intuitive Envelope Theorem," 2007 Annual Meeting, July 29-August 1, 2007, Portland, Oregon TN 2015-43, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  7. Jørgensen, Thomas H., 2013. "Structural estimation of continuous choice models: Evaluating the EGM and MPEC," Economics Letters, Elsevier, vol. 119(3), pages 287-290.
  8. Carroll, Christopher D., 2006. "The method of endogenous gridpoints for solving dynamic stochastic optimization problems," Economics Letters, Elsevier, vol. 91(3), pages 312-320, June.
  9. Hintermaier, Thomas & Koeniger, Winfried, 2010. "The method of endogenous gridpoints with occasionally binding constraints among endogenous variables," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 2074-2088, October.
  10. Clausen, Andrew & Strub, Carlo, 2013. "A General and Intuitive Envelope Theorem," SIRE Discussion Papers 2015-43, Scottish Institute for Research in Economics (SIRE).
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