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The Distribution of the Instrumental Variables Estimator and Its t-Ratio When the Instrument Is a Poor One

  • Nelson, Charles R
  • Startz, Richard

Instrumental variables estimation is used when there is reason to suspect feedback from a dependent variable to the explanatory variable, but the results will tend to be highly misleading if the instrument is a poor one. In this case, the distribution of the estimated coefficient is concentrated around a value that is related to the amount of feedback rather than to the true coefficient. When the true coefficient is zero, the instrumental variables coefficient will nevertheless appear to be highly significant, and this effect increases with the amount of feedback. Thus, it is in the cases where least squares is a poor estimator that instrumental variables with a poor instrument will be even worse. Some guidelines for practice are suggested. Copyright 1990 by the University of Chicago.

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Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 63 (1990)
Issue (Month): 1 (January)
Pages: S125-40

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Handle: RePEc:ucp:jnlbus:v:63:y:1990:i:1:p:s125-40
Contact details of provider: Web page: http://www.journals.uchicago.edu/JB/

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  1. Charles R. Nelson & Richard Startz, 1988. "Some Further Results on the Exact Small Sample Properties of the Instrumental Variable Estimator," NBER Technical Working Papers 0068, National Bureau of Economic Research, Inc.
  2. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  3. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
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