Improving Policy Functions in High-Dimensional Dynamic Games

Carlos A. Manzanares, Ying Jiang and Patrick Bajari

No 21124, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper, we propose a method for finding policy function improvements for a single agent in high-dimensional Markov dynamic optimization problems, focusing in particular on dynamic games. Our approach combines ideas from literatures in Machine Learning and the econometric analysis of games to derive a one-step improvement policy over any given benchmark policy. In order to reduce the dimensionality of the game, our method selects a parsimonious subset of state variables in a data-driven manner using a Machine Learning estimator. This one-step improvement policy can in turn be improved upon until a suitable stopping rule is met as in the classical policy function iteration approach. We illustrate our algorithm in a high-dimensional entry game similar to that studied by Holmes (2011) and show that it results in a nearly 300 percent improvement in expected profits as compared with a benchmark policy.

JEL-codes: C44 C55 C57 C73 L1 (search for similar items in EconPapers)
Date: 2015-04
New Economics Papers: this item is included in nep-gth
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