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GMM Estimation with Noncausal Instruments

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  • Lanne, Markku
  • Saikkonen, Pentti

Abstract

Lagged variables are often used as instruments when the generalized method of moments (GMM) is applied to time series data. We show that if these variables follow noncausal autoregressive processes, their lags are not valid instruments and the GMM estimator is inconsistent. Moreover, in this case, endogeneity of the instruments may not be revealed by the J-test of overidentifying restrictions that may be inconsistent and, as shown by simulations, its finite-sample power is, in general, low. Although our explicit results pertain to a simple linear regression, they can be easily generalized. Our empirical results indicate that noncausality is quite common among economic variables, making these problems highly relevant.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23649.

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Date of creation: Sep 2009
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Handle: RePEc:pra:mprapa:23649

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Keywords: Noncausal autoregression; instrumental variables; test of overidentifying restrictions;

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References

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  1. Markku Lanne & Pentti Saikkonen, 2008. "Modeling Expectations with Noncausal Autoregressions," Economics Working Papers ECO2008/20, European University Institute.
  2. K. Newey, Whitney, 1985. "Generalized method of moments specification testing," Journal of Econometrics, Elsevier, vol. 29(3), pages 229-256, September.
  3. Hansen, Bruce E & West, Kenneth D, 2002. "Generalized Method of Moments and Macroeconomics," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(4), pages 460-69, October.
  4. Breid, F. Jay & Davis, Richard A. & Lh, Keh-Shin & Rosenblatt, Murray, 1991. "Maximum likelihood estimation for noncausal autoregressive processes," Journal of Multivariate Analysis, Elsevier, vol. 36(2), pages 175-198, February.
  5. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
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Cited by:
  1. Lof, Matthijs, 2011. "Noncausality and Asset Pricing," MPRA Paper 30519, University Library of Munich, Germany.
  2. Lanne, Markku & Nyberg, Henri & Saarinen, Erkka, 2011. "Forecasting U.S. Macroeconomic and Financial Time Series with Noncausal and Causal AR Models: A Comparison," MPRA Paper 30254, University Library of Munich, Germany.
  3. Lof, Matthijs, 2011. "GMM estimation with noncausal instruments under rational expectations," MPRA Paper 35536, University Library of Munich, Germany.
  4. Lanne, Markku & Luoto, Jani, 2011. "Autoregression-Based Estimation of the New Keynesian Phillips Curve," MPRA Paper 29801, University Library of Munich, Germany.

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