Estimation of dynamic linear models in short panels with ordinal observation of the endogenous variables

Publication type

Conference Paper


BHPS-2005 Conference: the 2005 British Household Panel Survey Research Conference, 30 June -2 July 2005, Colchester, UK


Publication date

June 1, 2005


This research is concerned with the use of subjective measures of financial well-being
as indicators to be used in welfare analysis as an alternative or supplement to income
variables. The BHPS contains questions asking respondents to summarise how well
they are managing financially, using an ordinal scale. This is asked separately about
the current period and about change since the previous year. The paper proposes and
implements a new statistical approach to modelling these responses when there is the
possibility of slow dynamic adjustment of perceptions. This approach uses a latent
autoregressive or autoregressive-moving average structure to model the underlying
continuous perceptions, with these latent variables converted into ordinal form via the
usual ordered probit mechanism. We use simulated maximum likelihood estimators,
with the GHK simulator used to evaluate the required high-dimensional rectangle
probabilities. We demonstrate that this model fits the BHPS considerably better than
the more common Heckman state-dependence model. We test the hypothesis that
responses to the questions on current financial status and recent change are mutually
consistent. The results suggest that perceptions are subject to significant adjustment
delays and that there may be persistent inconsistencies between responses to the
current and retrospective questions.




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