Dynamic decisions under subjective expectations: a structural analysis

Yonghong An, Yingyao Hu and Ruli Xiao
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Yonghong An: Institute for Fiscal Studies
Ruli Xiao: Institute for Fiscal Studies and Indiana University

No CWP11/18, CeMMAP working papers from Centre for Microdata Methods and Practice, Institute for Fiscal Studies

Abstract: This 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 identi ed and estimated from the observed conditional choice probabilities in both finite and infi nite horizon cases. Our identi cation of subjective expectations is nonparametric and can be expressed as a closed-form function of the observed conditional choice probabilities. 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 identi cation; estimation. (search for similar items in EconPapers)
Date: 2018-02-05
New Economics Papers: this item is included in nep-dcm and nep-upt
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Citations: View citations in EconPapers (7)

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Related works:
Journal Article: Dynamic decisions under subjective expectations: A structural analysis (2021)
Working Paper: Dynamic Decisions under Subjective Expectations: A Structural Analysis (2018)
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