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Faculty of Economics

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Bhattacharya, D.

The Empirical Content of Binary Choice Models


Vol. 89 no. 1 pp. 457-474 (2021)

Abstract: An important goal of empirical demand analysis is choice and welfare prediction on counterfactual budget sets arising from potential policy-interventions. Such predictions are more credible when made without arbitrary functional-form/distributional assumptions, and instead based solely on economic rationality, i.e. that choice is consistent with utility maximization by a heterogeneous population. This paper investigates nonparametric economic rationality in the empirically important context of binary choice. We show that under general unobserved heterogeneity, economic rationality is equivalent to a pair of Slutsky-like shape-restrictions on choice-probability functions. The forms of these restrictions differ from Slutsky-inequalities for continuous goods. Unlike McFadden-Richter's stochastic revealed preference, our shape-restrictions (a) are global, i.e. their forms do not depend on which and how many budget-sets are observed, (b) are closed-form, hence easy to impose on parametric/semi/non-parametric models in practical applications, and (c) provide computationally simple, theory-consistent bounds on demand and welfare predictions on counterfactual budget-sets.

Keywords: Binary choice, general heterogeneity, income effect, utility maximization, integrability/rationalizability, Slutsky inequality, shape-restrictions

JEL Codes: C14, C25, D12

Author links: Debopam Bhattacharya  

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