Identifying the Discount Factor in Dynamic Discrete Choice Models

August 2018
Jaap H. Abbring, Oystein Daljord

Empirical applications of dynamic discrete choice models usually either take the discount factor to be known or rely on ad hoc functional form assumptions to identify and estimate it. We give identification results under economically motivated exclusion restrictions on primitive utilities. We show that each such exclusion restriction leads to an easily interpretable moment condition with the discount factor as the only unknown parameter. The identified set of discount factors that solves this condition is finite, but not necessarily a singleton. Consequently, in contrast to common intuition, an exclusion restriction does not provide point identification. In applications, multiple exclusion restrictions are often available. The discount factor can be set estimated from the corresponding moment conditions using existing methods without solving the choice model. Finally, we show that exclusion restrictions have nontrivial empirical content: The implied moment conditions impose restrictions on choices that are absent from the unconstrained model.

The working paper can be found here.