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I am reading Jeong, Kim, Manovskii 2015 and in the paper they apply "a nonlinear least-squares method" to estimate a log-wage equation, enter image description here, where $D, \Pi$, all $\lambda$s $\theta$s, and $\alpha$ are coefficients, $j$, $e$ are age and experience, and $s$, $x$ means sex and education group.

I understand the "nonlinear least-squares method" by simply doing $$\min_{D, \Pi, \lambda, \theta, \alpha} \sum_{i,t}\hat{\epsilon}_{i,t}^{2}$$. But I have no idea what are the common approaches (both in terms of theory and in terms of statistic packages or programming) to estimate and are there any important issues or cautions in such estimations (e.g. high dimension, or in the case here the age and the experience is likely to be positively correlated)?

An additional question specific to the case here is that do we need panel data like PSID data for the estimation here? Put it in a different way, can we use repeated cross-sectional data like CPS data to estimate this log wage equation?

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  • $\begingroup$ Hi: This not a specific comment to your particular problem but, in general, if you're using optimization software that allows for gradients, then it's best to use them when you call the function. The algorithm will have an easier time finding a solution and won't have to rely on numerical approximations for the gradients. $\endgroup$
    – mark leeds
    Aug 10 at 10:55
  • $\begingroup$ @markleeds Thanks for comment. If in general the method is to use optimization packages, how can I get the standard deviations? Bootstrapping? $\endgroup$ Aug 10 at 11:00
  • $\begingroup$ you can use the resulting hessian as an asymptotic approximation. For reasonable sample size, that should be okay. $\endgroup$
    – mark leeds
    Aug 10 at 17:46
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Suppose the relationship between $y_{i,t}\equiv\log w_{i,t}$ and $z_{i,t}\equiv\left(s_{i,t},j_{i,t},e_{i,t},x_{i,t}\right)^{\top}$ is given by

$$y_{i,t}=g\left(z_{i,t}\right)+\varepsilon_{i,t},$$

where $g\left(\cdot\right)$ can be nonlinear. There can be two cases for this problem

  • $g\left(\cdot\right)$ is unknown. For example, if one use sieve estimation, which may lead to the high dimension problem you mentioned, to address this problem, he can apply some regulation methods like LASSO. However, this is not the case in this question, so I won't talk too much.

  • $g\left(\cdot\right)=m\left(z_{i,t};\beta\right)$ where the form of $m\left(\cdot\right)$ is known, like in this question, and $\beta=\left(D,\Pi,\lambda,\theta,\alpha\right)^{\top}$. This happens when there exists some economic theory or model that yields this kind of relationship, or the user needs to identify and analyze how the covariates affects the outcome. In this case, the NLS estimator is easier to analyze since it can be seen a special case of extreme estimator:

$$\hat{\beta}=\mathop{\arg\min}_{\beta\in\mathcal{B}}\hat{S}\left(\beta\right),$$ where $\hat{S}\left(\beta\right)\equiv\frac{1}{NT}\sum_{i=1}^{N}\sum_{t=1}^{T}\left(y_{i,t}-m\left(z_{i,t};\beta\right)\right)^{2}$. Following the similar discussion as in extreme estimators, if $\mathcal{B}$ is compact and $\hat{S}\left(\beta\right)$ converge uniformly in probability to some nonrandom function which has a unique minimizer, then $\hat{\beta}$ is consistent, and will be asymptotically normal under additional conditions.

To solve $\hat{\beta}$, you can first write the FOC of this problem $$\frac{1}{NT}\sum_{i=1}^{N}\sum_{t=1}^{T}\left(y_{i,t}-m\left(z_{i,t};\hat{\beta}\right)\right)\frac{\partial m\left(z_{i,t};\hat{\beta}\right)}{\partial \beta}=0.$$ Generally there is no closed form solution for $\hat{\beta}$ hence it must be found by numerical methods. There are two iteration algorithms that can be used.

  • Gauss-Newton method

$$\beta_{r+1}=\beta_{r}-\frac{1}{2}\left(\sum_{i=1}^{N}\sum_{t=1}^{T}\frac{\partial m\left(z_{i,t};\beta_{r}\right)}{\partial\beta}\frac{\partial m\left(z_{i,t};\beta_{r}\right)}{\partial\beta^{\top}}\right)^{-1}\frac{\partial\hat{S}\left(\beta_{r}\right)}{\partial \beta}.$$

  • Newton-Raphson Algorithm $$\beta_{r+1}=\beta_{r}-\left(\frac{\partial^{2}\hat{S}\left(\beta_{r}\right)}{\partial\beta\partial\beta^{\top}}\right)^{-1}\frac{\partial \hat{S}\left(\beta_{r}\right)}{\partial\beta},$$ which requires the matrix in bracket being positive definite to converge.

As for programming, I'm not sure if any statistics software has NLS function. You can google it and check the help document if have one. If there's no existing package, you can use optimize to solve the origin minimization problem, or fsolve to find numerical solution to above FOC.


Update for std. Suppose $\sqrt{NT}\left(\hat{\beta}-\beta_{0}\right)\overset{d}{\to}\mathcal{N}\left(0,V\right)$, then $V$ can be estimated by $$\begin{align*}\hat{V}&\equiv\left(\frac{1}{NT}\sum_{i=1}^{N}\sum_{t=1}^{T}\frac{\partial m\left(z_{i,t};\hat{\beta}\right)}{\partial\beta}\frac{\partial m\left(z_{i,t};\hat{\beta}\right)}{\partial\beta^{\top}}\right)^{-1}\\ &\left(\frac{1}{NT}\sum_{i=1}^{N}\sum_{t=1}^{T}\frac{\partial m\left(z_{i,t};\hat{\beta}\right)}{\partial\beta}\frac{\partial m\left(z_{i,t};\hat{\beta}\right)}{\partial\beta^{\top}}\hat{\varepsilon}_{i,t}^{2}\right)\left(\frac{1}{NT}\sum_{i=1}^{N}\sum_{t=1}^{T}\frac{\partial m\left(z_{i,t};\hat{\beta}\right)}{\partial\beta}\frac{\partial m\left(z_{i,t};\hat{\beta}\right)}{\partial\beta^{\top}}\right)^{-1}.\end{align*}$$

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  • $\begingroup$ Thanks for the nice derivations. R offers many different packages for doing maximization of non-linear functions. You can look at the optimization task view on cran for details. $\endgroup$
    – mark leeds
    Aug 10 at 17:48

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