Dynamic Discrete Choice with Serially Correlated Shocks and an Application to Mortgage Default in Colombia

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Empirical Micro Seminar
University of Pennsylvania

3718 Locust Walk
395 McNeil

Philadelphia, PA

United States

Joint with: Salvador Navarro, University of Wisconsin-Madison We propose a framework for estimating dynamic behavioral models accounting for the presence of unobserved state variables that are correlated across individuals and across time periods. We extend the standard literature on the structural estimation of dynamic models by incorporating an unobserved aggregate correlated shock that affects the individuals' static payoffs and the dynamic continuation payoffs associated with different decisions. Given a standard parametric specification the dynamic prob- lem, we show that the aggregate shocks are identified from the variation in the observed aggregate behavior. The shocks and their transition are separately identified, provided there is enough cross-sectional variation of the observed states. We use our framework to estimate a model of mortgage default for a cohort of Colombian debtors between 1997 and 2004. Results indicate that the dynamic structure and the unobserved heterogeneity are crucial for identifying correctly the impact of different factors on default behavior. The estimation of discrete choice dynamic models is limited by the ability of standard microe- conometric techniques to incorporate a rich pattern of unobserved heterogeneity affecting the University of Wisconsin-Madison 1 For more information, contact Petra Todd.

Juan Esteban Carranza

University of Wisconsin-Madison

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