The Plan for Day Two

Practice and pitfalls

(1) Natural experiments as interesting sources of
instrumental variables
(2) The consequences of weak instruments for
causal inference
(3) Some useful IV diagnostics
(4) Walk through an empirical application
Goal = provide concrete examples of
instrumental variables methods
Instrumental
Variables and Natural Experiments
What is a natural experiment?
situations where the forces of nature or government
policy have conspired to produce an environment
somewhat akin to a randomized experiment
Angrist and Krueger (2001, p. 73)
Natural experiments can provide a useful
source of exogenous variation in problematic
regressors
But they require detailed institutional knowledge
Instrumental
Variables and Natural Experiments
Some natural experiments in economics
Existing policy differences, or changes that affect
some jurisdictions (or groups) but not others
Minimum wage rate
Excise taxes on consumer goods
Unemployment insurance, workers compensation
Unexpected shocks to the local economy
Coal prices and the Middle East oil embargo (1973)
Agricultural production and adverse weather events
Instrumental
Variables and Natural Experiments
Some potential pitfalls
Not all policy differences/changes are exogenous
Political factors and past realizations of the response
variable can affect existing policies or policy changes
Generalizability of causal effect estimates
Results may not generalize beyond the units under study
Heterogeneity in causal effects
Results may be sensitive to the natural experiment
chosen in a specific study (L.A.T.E.)
Instrumental
Variables and Natural Experiments
Some natural experiments of criminological
interest
Levitt (1996) = prison population crime rate
Levitt (1997) = police hiring crime rate
Apel et al. (2008) = youth employment delinquency
Some natural experiments not of criminological
interest, but interesting nonetheless
Angrist and Evans (1998) = fertility labor supply
Levitt (1996), Q.J .E.
Large decline in crime did not accompany the
large increase in prison population (1971-1993)
Prima fascia evidence of prison ineffectiveness
But...increased prison use could mask what
would have been a greater increase in crime
Underlying determinants of crime probably worsened
And...prison population probably responded to
crime increase
Levitt (1996), Q.J .E.
Prison overcrowding legislation
Population caps, prohibition of double celling
In 12 states, the entire prison system came under
court control
AL, AK, AR, DE, FL, MS, NM, OK, RI, SC, TN, TX
Relationship between legislation and prisons
Prior to filing, prison growth outpaced national
average by 2.3 percent
After filing, prison growth was 5.1 percent slower
Levitt (1996), Q.J .E.
Prisons
Under Court
Control
Prison
Population
Growth

Crime Rate
Growth
Logic of the instrumental variable in this study
Court rulings concerning prison capacity cannot be correlated
with the unobserved determinants of crime rate changes
Or...the only reason court rulings are related to crime is
because they limit prison population growth
Levitt (1996), Q.J .E.
2SLS model yields a prison
effect on crime at least four
times as high as the LS model
Violent crime rate
b
LS
= .099 (s.e. = .033)
b
IV
= .424 (s.e. = .201)
Property crime rate
b
LS
= .071 (s.e. = .019)
b
IV
= .321 (s.e. = .138)
A 10% increase in prison size
produces a 4.2% decrease in
violent crime and a 3.2%
decrease in property crime
Levitt (1996), Q.J .E.
L.A.T.E. = effect of prison growth on crime
among states under court order to slow growth
Some relevant observations
Generalizability = predominately Southern states
Large prison populations, unusually fast prison growth
T.E. heterogeneity = (slowed) prison growth due to
court-ordered prison reductions may be differentially
related to crime rates
Other IVs could lead to different causal effect estimates
Levitt (1997), A.E.R.
Breaking the simultaneity in the police-crime
connection
When more police are hired, crime should decline
But...more police may be hired during crime waves
Election cycles and police hiring
Increases in size of police force disproportionately
concentrated in election years
Growth is 2.1% in mayoral election years, 2.0% in
gubernatorial election years, and 0.0% in non-
election years
Levitt (1997), A.E.R.
However...can election cycles affect crime
rates through other spending channels?
Ex., education, welfare, unemployment benefits
If so, all of these other indirect channels must be
netted out

Growth in
Police
Manpower
+
Growth in
Crime Rate
Election
Year
Levitt (1997), A.E.R.
First-stage
coefficients
Reduced-form
coefficients
Levitt (1997), A.E.R.
Comparative estimates of the effect of police
manpower on city crime rates
Violent crime rate
Levels: b
LS
= +.28 (s.e. = .05)
Changes: b
LS
= .27 (s.e. = .06)
Changes: b
IV
= 1.39 (s.e. = .55)
Property crime rate
Levels: b
LS
= +.21 (s.e. = .05)
Changes: b
LS
= .23 (s.e. = .09)
Changes: b
IV
= .38 (s.e. = .83)
Levitt (1997), A.E.R.
Follow-up instrumental variables studies of
the police-crime relationship in the U.S.
Levitt (2002) = Number of firefighters
Klick and Tabarrok (2005) = Washington, DC,
terrorism alert levels post-9/11
Evans and Owens (2007) = Grants from the
federal Office of C.O.P.S.
These findings basically replicated those from
Levitts (1997) original study
Apel et al. (2008), J .Q.C.
What effect does working have on adolescent
behavior?
Prior research suggests the consequences of work
are uniformly negative
Focus on work intensity rather than work per se
Youth Worker Protection Act
Problem of non-random selection into youth
labor market
Especially pronounced for high-intensity workers
Apel et al. (2008), J .Q.C.
Something interesting happens at age 16
Youth work is no longer governed by the federal
Fair Labor Standards Act (F.L.S.A.)
Apel et al. (2008), J .Q.C.
F.L.S.A. governs employment of all 15 year
olds during the school year
No work past 7:00 pm
Maximum 3 hours/day and 18 hours/week
But, F.L.S.A. expires for 16 year olds
And...every state has its own law governing 16-
year-old employment
Thus, youth age into less restrictive regimes that
vary across jurisdictions
Apel et al. (2008), J .Q.C.
Change in work intensity at 15-16 transition among
15-year-old non-workers
Magnitude of change
is an increasing
function of the
number of hours
allowed at age 16
State Child Labor Law Model 1 Model 2 Model 3
Hours per Week 0.32 (.05)***
No Limit 11.43 (1.6)***
Hours per Weekday 1.19 (.19)***
No Limit 9.37 (1.3)***
Work Curfew 2.19 (.27)***
No Limit 23.83 (2.7)***
R-square .400 .401 .409
R-square with IVs .014 .015 .023
Partial R-square for IVs .023 .025 .037
F-test for IVs 26.2 28.3 41.9
Approx. relative bias .000 .000 .000
Apel et al. (2008), J .Q.C.
Apel et al. (2008), J .Q.C.
A 20-hour increase in the number of hours worked per
week reduces the variety of delinquent behavior by
0.47 (.023320)
Angrist and Krueger (1991), J .L.E.
Returns to education (Y = wages)
Problem of omitted ability bias
Years of schooling vary by quarter of birth
Compulsory schooling laws, age-at-entry rules
Someone born in Q1 is a little older and will be
able to drop out sooner than someone born in Q4
Q.O.B. can be treated as a useful source of
exogeneity in schooling
Angrist and Krueger (1991), J .L.E.
People born in Q1 do
obtain less schooling
But pay close attention to
the scale of the y-axis
Mean difference between
Q1 and Q4 is only 0.124,
or 1.5 months
So...need large N since
R
2
X,Z
will be very small
A&K had over 300k for
the 1930-39 cohort
Source: Angrist and Krueger (1991), Figure I
Angrist and Krueger (1991), J .L.E.
Final 2SLS model interacted QOB with year of
birth (30), state of birth (150)
OLS: b = .0628 (s.e. = .0003)
2SLS: b = .0811 (s.e. = .0109)
Least squares estimate does not appear to be
badly biased by omitted variables
But...replication effort identified some pitfalls in this
analysis that are instructive
Bound,
Jaeger, and Baker (1995), J .A.S.A.
Potential problems with QOB as an IV
Correlation between QOB and schooling is weak
Small Cov(X,Z) introduces finite-sample bias, which will be
exacerbated with the inclusion of many IVs
QOB may not be completely exogenous
Even small Cov(Z,e) will cause inconsistency, and this will
be exacerbated when Cov(X,Z) is small
QOB qualifies as a weak instrument that may
be correlated with unobserved determinants of
wages (e.g., family income)
Bound,
Jaeger, and Baker (1995), J .A.S.A.
Even if the instrument is good, matters can
be made far worse with IV as opposed to LS
Weak correlation between IV and endogenous
regressor can pose severe finite-sample bias
Andreally large samples wont help, especially if there
is even weak endogeneity between IV and error
First-stage diagnostics provide a sense of
how good an IV is in a given setting
F-test and partial-R
2
on IVs
Useful
Diagnostic Tools for IV Models
Tests of instrument relevance
Weak IVs Large variance of b
IV
as well as
potentially severe finite-sample bias
Tests of instrument exogeneity
Endogenous IVs Inconsistency of b
IV
that
makes it no better (and probably worse) than b
LS

Durbin-Wu-Hausman test
Endogeneity of the problem regressor(s)
Tests of Instrument Relevance
Diagnostics based on the F-test for the joint
significance of the IVs
Nelson and Startz (1990); Staiger and Stock (1997)
Bound, Jaeger, and Baker (1995)
Partial R-square for the IVs
Shea (1997)
There is a growing econometric literature
on the weak instrument problem
Tests of Instrument Exogeneity
Model must be overidentified, i.e., more IVs
than endogenous Xs
H
0
: All IVs uncorrelated with structural error
Overidentification test:
1. Estimate structural model
2. Regress IV residuals on all exogenous variables
3. Compute NR
2
and compare to chi-square
df = # IVs # endogenous Xs
Durbin-Wu-Hausman (DWH) Test
Balances the consistency of IV against the
efficiency of LS
H
0
: IV and LS both consistent, but LS is efficient
H
1
: Only IV is consistent
DWH test for a single endogenous regressor:
DWH = (b
IV
b
LS
) / (s
2
b
IV
s
2
b
LS
) ~ N(0,1)
If |DWH| > 1.96, then X is endogenous and IV is
the preferred estimator despite its inefficiency
Durbin-Wu-Hausman (DWH) Test
A roughly equivalent procedure for DWH:
1. Estimate the first-stage model
2. Include the first-stage residual in the structural
model along with the endogenous X
3. Test for significance of the coefficient on residual
Note: Coefficient on endogenous X in this
model is b
IV
(standard error is smaller, though)
First-stage residual is a generated regressor
Software Considerations
I have a strong preference for Stata
Classic routine (-ivreg-) as well as a user-written
one with a lot more diagnostic capability (-ivreg2-)
Non-linear models: -ivprobit- and -ivtobit-
Panel models: -xtivreg- and -xtivreg2-
Useful post-estimation routines
Overidentification: -overid-
Endogeneity of X in LS model: -ivendog-
Heteroscedasticity: -ivhettest-
Software Considerations
Basic model specification in Stata
ivreg y (x = z) w [weight = wtvar], options
y = dependent variable
x = endogenous variable
z = instrumental variable
w = control variable(s)
Useful options: first, ffirst, robust, cluster(varname)
Software Considerations
For SAS users: Proc Syslin (SAS/ETS)
Basic command:
proc syslin data=dataset 2sls options1;
endogenous x;
instruments z w;
model y = x w / options2;
weight wtvar;
run;
Useful options1: first
Useful options2: overid
Software Considerations
For SPSS users: 2SLS
Basic command:
2sls y with x w
/ instruments z w
/ constant.
For point-and-click aficionados
Analyze Regression Two-Stage Least Squares
DEPENDENT, EXPLANATORY, and INSTRUMENTAL
Software Considerations
For Limdep users: 2SLS
Basic command:
2SLS ; Lhs = y
; Rhs = one, x, w
; Inst = one, z, w
; Wts = wtvar
; Dfc $

Application: Adolescent
Work and Delinquent Behavior
Prior research shows a positive correlation
between teenage work and delinquency
Reasons to suspect serious endogeneity bias
2nd wave of the NLSY97 (N = 8,368)
Y = 1 if committed delinquent act (31.9%)
X = 1 if worked in a formal job (52.6%)
Z
1
= 1 if child labor law allows 40+ hours (14.2%)
Z
2
= 1 if no child labor restriction in place (39.6%)
Regression
Model Ignoring Endogeneity
. reg pcrime work if nomiss==1 & wave==2

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 1, 8366) = 6.33
Model | 1.37395379 1 1.37395379 Prob > F = 0.0119
Residual | 1815.97786 8366 .217066443 R-squared = 0.0008
-------------+------------------------------ Adj R-squared = 0.0006
Total | 1817.35182 8367 .217204711 Root MSE = .4659

------------------------------------------------------------------------------
pcrime | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
work | .0256633 .0102005 2.52 0.012 .0056677 .0456588
_cons | .3053242 .0074009 41.26 0.000 .2908167 .3198318
------------------------------------------------------------------------------

Teenage workers significantly more delinquent
Modest effect but consistent with prior research
First-Stage Model
. reg work law40 nolaw if nomiss==1 & wave==2

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 2, 8365) = 626.64
Model | 271.829722 2 135.914861 Prob > F = 0.0000
Residual | 1814.33364 8365 .216895832 R-squared = 0.1303
-------------+------------------------------ Adj R-squared = 0.1301
Total | 2086.16336 8367 .249332301 Root MSE = .46572

------------------------------------------------------------------------------
work | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
law40 | .0688902 .0154383 4.46 0.000 .0386274 .099153
nolaw | .3818684 .0110273 34.63 0.000 .3602521 .4034847
_cons | .3655636 .0074883 48.82 0.000 .3508847 .3802425
------------------------------------------------------------------------------

State child labor laws affect probability of work
This is a really strong first stage (F, R
2
)
Two-Stage Least Squares Model
. ivreg pcrime (work = law40 nolaw) if nomiss==1 & wave==2

Instrumental variables (2SLS) regression

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 1, 8366) = 6.86
Model | -19.5287923 1 -19.5287923 Prob > F = 0.0088
Residual | 1836.88061 8366 .219564978 R-squared = .
-------------+------------------------------ Adj R-squared = .
Total | 1817.35182 8367 .217204711 Root MSE = .46858

------------------------------------------------------------------------------
pcrime | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
work | -.0744352 .0284206 -2.62 0.009 -.1301466 -.0187238
_cons | .3580171 .0158135 22.64 0.000 .3270187 .3890155
------------------------------------------------------------------------------
Instrumented: work
Instruments: law40 nolaw
------------------------------------------------------------------------------

What
Do the Models Suggest Thus Far?
Completely different conclusions!
OLS = Teenage work is criminogenic (b = +.026)
Delinquency risk increases by 8.5 percent (base = .305)
2SLS = Teenage work is prophylactic (b = .074)
Delinquency risk decreases by 20.7 percent (base = .358)
Which model should we believe?
We still have some additional diagnostic work to do
to evaluate the 2SLS model
Overidentification test, Hausman test
Regression-
Based Overidentification Test
. reg IVresid law40 nolaw if nomiss==1 & wave==2

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 2, 8365) = 0.25
Model | .111648085 2 .055824043 Prob > F = 0.7755
Residual | 1836.76895 8365 .219577878 R-squared = 0.0001
-------------+------------------------------ Adj R-squared = -0.0002
Total | 1836.8806 8367 .219538735 Root MSE = .46859

------------------------------------------------------------------------------
IVresid | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
law40 | .010988 .0155334 0.71 0.479 -.0194613 .0414374
nolaw | .0016436 .0110953 0.15 0.882 -.020106 .0233931
_cons | -.0022127 .0075344 -0.29 0.769 -.0169821 .0125567
------------------------------------------------------------------------------

Overidentification test = 8,368 .0001 = .8368 ~
2
(1)
Overidentification
Test from the Software
. overid

Tests of overidentifying restrictions:
Sargan N*R-sq test 0.509 Chi-sq(1) P-value = 0.4757
Basmann test 0.508 Chi-sq(1) P-value = 0.4758

IVs jointly pass the exogeneity requirement
Notice that -overid- provides a global test, whereas
the regression-based approach allows you to test
the IVs jointly as well as individually
Durbin-Wu-Hausman
(DWH) Test Estimated by Hand
Summary coefficients
OLS model: b = +.026, s.e. = .010
2SLS model: b = .074, s.e. = .028
Notice the size of the 2SLS standard error
DWH = (.074 .026) / (.028
2
.010
2
) 3.82
CONCLUSION: Least squares estimate of the
work effect is biased and inconsistent
The 2SLS estimate is preferred
Regression-Based DWH Test
. reg pcrime work FSresid if nomiss==1 & wave==2

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 2, 8365) = 10.40
Model | 4.50567523 2 2.25283761 Prob > F = 0.0000
Residual | 1812.84614 8365 .216718009 R-squared = 0.0025
-------------+------------------------------ Adj R-squared = 0.0022
Total | 1817.35182 8367 .217204711 Root MSE = .46553

------------------------------------------------------------------------------
pcrime | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
work | -.0744352 .0282357 -2.64 0.008 -.1297842 -.0190862
FSresid | .1150956 .0302771 3.80 0.000 .0557449 .1744462
_cons | .3580171 .0157106 22.79 0.000 .3272204 .3888139
------------------------------------------------------------------------------

Coeff. on work is b
IV
, while t-test on FSresid is DWH
Standard error for work is underestimated, though
Or Just Let the
Software Give You the DWH Test
. ivendog

Tests of endogeneity of: work
H0: Regressor is exogenous
Wu-Hausman F test: 14.45067 F(1,8365) P-value = 0.00014
Durbin-Wu-Hausman chi-sq test: 14.43093 Chi-sq(1) P-value = 0.00015

Notice that -ivendog- provides a chi-square
test for DWH, but the z-test that we computed
by hand is easily recovered
(
2
) = z (14.43) = 3.80
Alternative Specifications for
the Work-Delinquency Association
IV probit model
Without IVs: b = +.072 (s.e. = .029)
With IVs: b = .207 (s.e. = .078)
Continuous work hours
Without IVs: b = +.0015 (s.e. = .0003)
With IVs: b = .0024 (s.e. = .0009)
Indicator for intensive work (>20 hours)
Without IVs: b = +.043 (s.e. = .012)
With IVs: b = .095 (s.e. = .036)
Alternative Specifications for
the Work-Delinquency Association
Control variables = gender, race, child, dropout,
family structure, family size, urbanicity, dwelling,
school suspension, unemployment rate, mobility
Binary work status
Without IVs: b = +.013 (s.e. = .010)
With IVs: b = .061 (s.e. = .029)
Continuous work hours
Without IVs: b = +.0007 (s.e. = .0003)
With IVs: b = .0023 (s.e. = .0010)
Intensive work indicator
Without IVs: b = +.020 (s.e. = .012)
With IVs: b = .085 (s.e. = .040)
So Where Do We Stand with
the Work-Delinquency Question?
Are child labor laws correlated with work?
YES = first-stage F is large
Are child labor laws good IVs?
YES = overidentification test is not rejected
Is teenage work endogenous?
YES = Hausman test is rejected
Prior research findings that teenage work
is criminogenic are selection artifacts
Stata Commands
for the Foregoing Example
Regression model ignoring endogeneity:
reg y x w
First-stage regression model:
reg x z1 z2 w
With controls and multiple IVs, test relevance:
test z1 z2
2SLS regression model:
ivreg y (x = z1 z2) w
Stata Commands
for the Foregoing Example
Manual post hoc commands
Get residuals for regression-based overid. test:
After 2SLS model: predict IVresid if e(sample), resid
Then: reg IVresid z1 z2
Get residuals for regression-based DWH test:
After first-stage model: predict FSresid if e(sample), resid
Then: reg y x w FSresid
Canned post hoc commands
After 2SLS model: overid and ivendog
NowWhat Happens if I Throw
in a Potentially Bogus Instrument?
Now there are three instrumental variables
Z
1
= 1 if child labor law allows 40+ hours (14.2%)
Z
2
= 1 if no child labor restriction in place (39.6%)
Z
3
= 1 if high unemployment rate in county (20.1%)
A little more difficult to tell a convincing story
that the unemployment rate is only related to
delinquency through work experience
But lets see what happens
First-Stage Model
. reg work law40 nolaw highun if nomiss==1 & wave==2

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 3, 8364) = 427.28
Model | 277.229696 3 92.4098987 Prob > F = 0.0000
Residual | 1808.93366 8364 .216276144 R-squared = 0.1329
-------------+------------------------------ Adj R-squared = 0.1326
Total | 2086.16336 8367 .249332301 Root MSE = .46505

------------------------------------------------------------------------------
work | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
law40 | .0636421 .0154519 4.12 0.000 .0333525 .0939317
nolaw | .3775975 .0110447 34.19 0.000 .3559472 .3992479
highun | -.0636009 .0127283 -5.00 0.000 -.0885517 -.0386502
_cons | .3808061 .0080759 47.15 0.000 .3649754 .3966368
------------------------------------------------------------------------------

So far so good and consistent with expectation
Two-Stage Least Squares Model
. ivreg pcrime (work = law40 nolaw highun) if nomiss==1 & wave==2

Instrumental variables (2SLS) regression

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 1, 8366) = 5.47
Model | -16.0635514 1 -16.0635514 Prob > F = 0.0194
Residual | 1833.41537 8366 .219150773 R-squared = .
-------------+------------------------------ Adj R-squared = .
Total | 1817.35182 8367 .217204711 Root MSE = .46814

------------------------------------------------------------------------------
pcrime | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
work | -.0657624 .0281159 -2.34 0.019 -.1208765 -.0106483
_cons | .3534516 .0156602 22.57 0.000 .3227537 .3841496
------------------------------------------------------------------------------
Instrumented: work
Instruments: law40 nolaw highun
------------------------------------------------------------------------------

Post-Hoc Diagnostics
. overid

Tests of overidentifying restrictions:
Sargan N*R-sq test 5.301 Chi-sq(2) P-value = 0.0706
Basmann test 5.301 Chi-sq(2) P-value = 0.0706

. ivendog

Tests of endogeneity of: work
H0: Regressor is exogenous
Wu-Hausman F test: 12.32811 F(1,8365) P-value = 0.00045
Durbin-Wu-Hausman chi-sq test: 12.31438 Chi-sq(1) P-value = 0.00045

Overidentification gives cause for concern
The p-value shouldnt be anywhere near 0.05
Follow-Up Overidentification Test
. reg IVresid law40 nolaw highun

Source | SS df MS Number of obs = 8368
-------------+------------------------------ F( 3, 8364) = 1.77
Model | 1.1613555 3 .387118499 Prob > F = 0.1511
Residual | 1832.25406 8364 .21906433 R-squared = 0.0006
-------------+------------------------------ Adj R-squared = 0.0003
Total | 1833.41541 8367 .219124586 Root MSE = .46804

------------------------------------------------------------------------------
IVresid | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
law40 | .0080993 .0155512 0.52 0.603 -.0223849 .0385836
nolaw | -.0035329 .0111156 -0.32 0.751 -.0253223 .0182565
highun | -.0277671 .0128101 -2.17 0.030 -.0528781 -.0026561
_cons | .0058369 .0081277 0.72 0.473 -.0100955 .0217693
------------------------------------------------------------------------------

Okayunemployment rate is problematic as IV
Conclusion from Diagnostic Tests
2SLS work effect is similar
Without unemployment, b = .074 (s.e. = .028)
With unemployment, b = .066 (s.e. = .028)
Butthe second model is invalidated because
the unemployment rate is not exogenous
If affects criminality through other channels
We need to control for all other indirect pathways, or
It should not be used as an IV at all
Closing Comments about
Instrumental Variables Studies
In general, a lagged value of the endogenous
regressor is not a good instrument
Traditional structural equation model uses lagged
values of X and Y as instruments to break the
simultaneity between the current values of X and Y
X
1
X
2
Y
1
Y
2
These models impose the
awfully strong assumption that
lagged values of X and Y only
affect the outcomes through
current values
Closing Comments about
Instrumental Variables Studies
Good IV models are generally interesting in
their own right, and should not be treated as
tack on analyses
Practice varies widely across disciplines
Some researchers write papers about their discovery and
application of a clever IV for some problem
Other researchers tack on IV models at the end of their
analysis, often poorly, as a way to convince readers that
their results are robust
Rules for Good Practice with
Instrumental Variables Models
IV models can be very informative, but its
your job to convince your audience
Show the first-stage model diagnostics
Even the most clever IV might not be sufficiently strongly
related to X to be a useful source of identification
Report test(s) of overidentifying restrictions
An invalid IV is often worse than no IV at all
Report LS endogeneity (DWH) test
Rules for Good Practice with
Instrumental Variables Models
Most importantly, TELL A STORY about why a
particular IV is a good instrument
Something to consider when thinking about
whether a particular IV is good
Does the IV, for all intents and purposes, randomize
the endogenous regressor?
Other Interesting IV Topics
I Just Dont Have Time to Cover
2SLS with a continuous treatment
Instrumental variables for sample selectivity
Generalized method of moments (IV-GMM)
Non-linear two-stage least squares (N2SLS)
Two-sample instrumental variables (TSIV)
Fixed-effects instrumental variables (FEIV)
Dynamic panel data estimators
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