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The Empirical Content of Binary Choice Models

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Document pages: 37 pages

Abstract: An important goal of empirical demand analysis is choice and welfareprediction on counterfactual budget sets arising from potentialpolicy-interventions. Such predictions are more credible when made withoutarbitrary functional-form distributional assumptions, and instead based solelyon economic rationality, i.e. that choice is consistent with utilitymaximization by a heterogeneous population. This paper investigatesnonparametric economic rationality in the empirically important context ofbinary choice. We show that under general unobserved heterogeneity, economicrationality is equivalent to a pair of Slutsky-like shape-restrictions onchoice-probability functions. The forms of these restrictions differ fromSlutsky-inequalities for continuous goods. Unlike McFadden-Richter s stochasticrevealed preference, our shape-restrictions (a) are global, i.e. their forms donot 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 practicalapplications, and (c) provide computationally simple, theory-consistent boundson demand and welfare predictions on counterfactual budget-sets.

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