The “difference” and “system” generalized method of moments (GMM) estimators for dynamic panel models are growing steadily in popularity. The estimators are designed for panels with short time dimensions (T), and by default they generate instruments sets whose number grows quadratically in T. The dangers associated with having many instruments relative to observations are documented in the applied literature. The instruments can overfit endogenous variables, failing to expunge their endogenous components and biasing coefficient estimates. Meanwhile they can vitiate the Hansen J test for joint validity of those instruments, as well as the difference-in-Sargan/Hansen test for subsets of instruments. The weakness of these specification tests is a particular concern for system GMM, whose distinctive instruments are only valid under a non-trivial assumption. Judging by current practice, many researchers do not fully appreciate that popular implementations of these estimators can by default generate results that simultaneously are invalid yet appear valid. The potential for type I errors—false positives—is therefore substantial, especially after amplification by publication bias. This paper explains the risks and illustrates them with reference to two early applications of the estimators to economic growth, Forbes (2000) on income inequality and Levine, Loayza, and Beck (LLB, 2000) on financial sector development. Endogenous causation proves hard to rule out in both papers. Going forward, for results from these GMM estimators to be credible, researchers must report the instrument count and aggressively test estimates and specification test results for robustness to reductions in that count.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Center for Global Development in its series Working Papers with number
125.
Find related papers by JEL classification: C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data G0 - Financial Economics - - General O40 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
This paper has been announced in the following NEP Reports:
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Simeon Djankov & Jose Montalvo & Marta Reynal-Querol, 2008.
"The curse of aid,"
Journal of Economic Growth,
Springer, vol. 13(3), pages 169-194, September.
[Downloadable!] (restricted)
Other versions:
Simeon Djankov & José Garcia Montalvo & Marta Reynal-Querol, 2005.
"The Curse of Aid,"
Economics Working Papers
870, Department of Economics and Business, Universitat Pompeu Fabra.
[Downloadable!]