Online Seminar: Normalizations and misspecification in skill formation models by Joachim Freyberger (University of Bonn)

Abstract: An important class of structural models investigates the determinants of skill formation and the optimal timing of interventions. To achieve point identification of the parameters, researcher typically normalize the scale and location of the unobserved skills. This paper shows that these seemingly innocuous restrictions can severely impact the interpretation of the parameters and counterfactual predictions. For example, simply changing the units of measurements of observed variables might yield ineffective investment strategies and misleading policy recommendations. To tackle these problems, this paper provides a new identification analysis, which pools all restrictions of the model, characterizes the identified set of all parameters without normalizations, illustrates which features depend on these normalization, and introduces a new set of important policy-relevant parameters that yield robust conclusions. As a byproduct, this paper also presents a general and formal definition of when restrictions are truly normalizations.