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Choosing the Optimal Set of Instruments from Large Instrument Sets

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    It is well known that instrumental variables (IV) estimation is sensitive to the choice of instruments both in small samples and asymptotically. Recently, Donald and Newey (2001) suggested a simple method for choosing the instrument set. The method involves minimising the approximate mean square error (MSE) of a given IV estimator where the MSE is obtained using refined asymptotic theory. An issue with the work of Donald and Newey (2001) is the fact that when considering large sets of valid instruments, it is not clear how to order the instruments in order to choose which ones ought to be included in the estimation. The present paper provides a possible solution to the problem using nonstandard optimisation algorithms. The properties of the algorithms are discussed. A Monte Carlo study illustrates the potential of the new method.

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    File URL: http://www.econ.qmul.ac.uk/papers/doc/wp534.pdf
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    Paper provided by Queen Mary University of London, School of Economics and Finance in its series Working Papers with number 534.

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    Date of creation: May 2005
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    Handle: RePEc:qmw:qmwecw:wp534
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    1. Donald, Stephen G. & Whitney Newey, 1999. "Choosing the Number of Instruments," Working papers 99-05, Massachusetts Institute of Technology (MIT), Department of Economics.
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