Working Paper: CEPR ID: DP15719
Authors: Pasquale Schiraldi; Matthew Levy
Abstract: This paper studies the non-parametric identification of the discount factor and utility function in the class of dynamic discrete-continuous choice (DDCC) models. In contrast to the discrete-only model we show the discount factor is identified. Our results further highlight why Euler equation estimation approaches that ignore agents’ discrete choices are inconsistent. We estimate utility and discount factors for a consumption- savings-retirement choice problem using the Panel Study of Income Dynamics (PSID). We show that the relative risk aversion parameter and the intertemporal elasticity of substitution are separately identified, and that the latter varies across agents due to the wealth-dependence of the surplus from the discrete choice. This surplus also implies that the value function may be locally convex in wealth, and we find that a simulated Universal Basic Income (UBI) policy counterintuitively benefits wealthier working households more than poorer ones due to this effect.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| discount factor identified when discrete and continuous choices are considered (D15) | discount factor identified when discrete-only models are used (G19) |
| failing to account for discrete choices (C25) | naive Euler equation approach yields inflated estimates of relative risk aversion (D11) |
| failing to account for discrete choices (C25) | naive Euler equation approach yields inflated estimates of intertemporal elasticity of substitution (D15) |
| discrete choice framework alters welfare implications (D11) | misrepresented in a continuous-only model (C32) |
| average annual discount factor estimated at 0.96 in full model (C51) | average annual discount factor estimated at 0.94 in naive approach (H43) |
| simulated universal basic income policy benefits wealthier working households more than poorer ones (H31) | structure of the discrete choice (C25) |