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A Note on the Theme of Too Many Instruments

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  • David Roodman

Abstract

The difference and system generalized method of moments (GMM) estimators are growing in popularity. As implemented in popular software, the estimators easily generate instruments that are numerous and, in system GMM, potentially suspect. A large instrument collection overfits endogenous variables even as it weakens the Hansen test of the instruments' joint validity. This paper reviews the evidence on the effects of instrument proliferation, and describes and simulates simple ways to control it. It illustrates the dangers by replicating Forbes ["American Economic Review" (2000) Vol. 90, pp. 869-887] on income inequality and Levine "et al." ["Journal of Monetary Economics"] (2000) Vol. 46, pp. 31-77] on financial sector development. Results in both papers appear driven by previously undetected endogeneity. Copyright (c) Center for Global Development 2009.

Suggested Citation

  • David Roodman, 2009. "A Note on the Theme of Too Many Instruments," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 71(1), pages 135-158, February.
  • Handle: RePEc:bla:obuest:v:71:y:2009:i:1:p:135-158
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • G0 - Financial Economics - - General
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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