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An Instrumental Variable Approach to Dynamic Models

Steven Berry () and Giovanni Compiani ()
Additional contact information
Steven Berry: Yale University - Department of Economics & Cowles Foundation; NBER
Giovanni Compiani: University of Chicago - Booth School of Business

No 2020-106, Working Papers from Becker Friedman Institute for Research In Economics

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.

Pages: 56 pages
Date: 2020
New Economics Papers: this item is included in nep-com and nep-env
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