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A New Perspective on Weak Instruments

Author

Listed:
  • Michael Keane

    (School of Economics)

  • Timothy Neal

    (UNSW School of Economics)

Abstract

We provide a simple survey of the weak instrument literature, aimed at giving practical advice to applied researchers. It is well-known that 2SLS has poor properties if instruments are exogenous but weak. We clarify these properties, explain weak instrument tests, and examine how behavior of 2SLS depends on instrument strength. A common standard for acceptable instruments is a ï¬ rst-stage F-statistic of at least 10. But 2SLS has poor properties in that context: It has very little power, and generates artiï¬ cially low standard errors precisely in those samples where it generates estimates most contaminated by endogeneity. This causes standard t-tests to give misleading results. In fact, one-tailed 2SLS t-tests suffer from severe size distortions unless F is in the thousands. Anderson-Rubin and conditional t-tests alleviate this problem, and should be used even with strong instruments. A ï¬ rst-stage F of 50 or more is necessary to give reasonable conï¬ dence that 2SLS will outperform OLS. Otherwise, OLS combined with controls for sources of endogeneity may be a superior research strategy to IV.

Suggested Citation

  • Michael Keane & Timothy Neal, 2021. "A New Perspective on Weak Instruments," Discussion Papers 2021-05a, School of Economics, The University of New South Wales.
  • Handle: RePEc:swe:wpaper:2021-05a
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    File URL: http://research.economics.unsw.edu.au/RePEc/papers/2021-05a.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Instrumental variables; weak instruments; 2SLS; endogeneity; F-test; size distortions of tests; Anderson-Rubin test; conditional t-test; Fuller; JIVE;
    All these keywords.

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