A New Paradigm: A Joint Test of Structural and Correlation Parameters in Instrumental Variables Regression When Perfect Exogeneity is Violated
The instrumental variables strategy is commonly employed in empirical research. For correct inference using this econometric technique, the instruments must be perfectly exogenous and relevant. In fact, the standard t-ratio test statistic used in this context yields unreliable and often inaccurate results even when there is only a slight violation of the exclusion restriction. It is crucial to realize that to make reliable inferences on the structural parameters we need to know the true correlation between the structural error and the instruments. The main innovation in this paper is to identify an appropriate test in this context: a joint null hypothesis of the structural parameters with the correlation between the instruments and the structural error term. Since correlation cannot be estimated, we propose a test statistic involving a grid search over correlation values. To address inference under violations of exogeneity, significant contributions have been made in the recent literature by assuming some degree of non-exogeneity. We introduce a new approach by deriving a modified t-statistic that corrects for the bias associated with non-exogeneity of the instrument. A key advantage of our approach over that of the previous literature is that we do not need to make any assumptions about the degree of violation of exogeneity either as possible values or prior distributions. In particular, our method is not a form of sensitivity analysis. Since our modified test statistic is continuous and monotonic in correlation it is easy to conduct inference by a simple grid search. Even though the joint null may seem to be limiting in interpreting rejection, we can still make accurate inferences on the structural parameters because of a feature of the grid search over correlation values. The procedure for calculating the modified coefficients and statistics is illustrated with two empirical examples.
|Date of creation:||14 Aug 2009|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://mpra.ub.uni-muenchen.de
More information through EDIRC
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.:
- Aviv Nevo & Adam M. Rosen, 2008.
"Identification with Imperfect Instruments,"
NBER Working Papers
14434, National Bureau of Economic Research, Inc.
- Berkowitz, Daniel & Caner, Mehmet & Fang, Ying, 2012.
"The validity of instruments revisited,"
Journal of Econometrics,
Elsevier, vol. 166(2), pages 255-266.
- Costas Meghir & MÃ¥rten Palme, 1999.
"Assessing the effect of schooling on earnings using a social experiment,"
IFS Working Papers
W99/10, Institute for Fiscal Studies.
- Meghir, Costas & Palme, Mårten, 1999. "Assessing the Effect of Schooling on Earnings Using a Social Experiment," SSE/EFI Working Paper Series in Economics and Finance 313, Stockholm School of Economics.
- Costas Meghir & Marten Palme, 2000. "Assessing the Effect of Schooling on Earnings Using a Social Experiment," Econometric Society World Congress 2000 Contributed Papers 0670, Econometric Society.
- Mehmet Caner, 2005.
"Near Exogeneity and Weak Identification in Generalized Empirical Likelihood Estimators: Fixed and Many Moment Asymptotics,"
- Mehmet Caner, 2006. "Near Exogeneity and Weak Identification in Generlized Empirical Likelihood estimators : Fixed and Many Moment Asymptotics," Working Papers 212, University of Pittsburgh, Department of Economics, revised Jan 2006.
- Daniel Berkowitz & Mehmet Caner & Ying Fang, 2006.
"Are "Nearly Exogenous" Instruments Reliable?,"
219, University of Pittsburgh, Department of Economics, revised Jan 2006.
- Mehmet Caner & Dan Berkowitz & Ying Fang, 2006. "Are Nearly Exogenous Instruments Reliable?," Working Papers 207, University of Pittsburgh, Department of Economics, revised Jan 2006.
- Daniel Berkowitz & Mehmet Caner & Ying Fang, 2013. "Are "Nearly Exogenous" Instruments Reliable?," Papers 2013-10-14, Working Paper.
- Richard Ashley, 2009. "Assessing the credibility of instrumental variables inference with imperfect instruments via sensitivity analysis," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(2), pages 325-337, 03.
- Richard A. Ashley., 2006. "Assessing the Credibility of Instrumental Variables Inference With Imperfect Instruments Via Sensitivity Analysis," Working Papers e06-9, Virginia Polytechnic Institute and State University, Department of Economics.
When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:16790. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht)
If references are entirely missing, you can add them using this form.