An Exposition of Structural Estimation of Discrete Dynamic Decision Processes

Abstract

In the analysis of dynamic decision problems, the vast majority of the literature has focused on normative aspects: what should a resource manager do to maximize a particular objective function? Rarely have resource economists attempted to answer the positive question: what decision problem does a resource manager actually solve? There are several candidate explanations for this emphasis on normative modeling, but in this chapter we take the perspective that although structural estimation of discrete dynamic decision problems is not especially difficult, it is difficult enough that most analysts require some explanation of why they should bother with it at all. We develop a general model of a discrete dynamic decision problem, distill it to a tractable form, and present the estimation methodology. We then provide an empirical example and investigate the implications of using a reduced-form static model of behavior when the underlying data-generating process is dynamic.