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LECTURE / DISCUSSION
Instrumental Variables
Miles
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true
Operating
cost
Corr(X,g) ú 0
Z is called an instrument.
j z ny n cov (z,y)
ˆ
IV ' '
j z nx n cov (z,x)
β
Y X
θ
cov (zy)
E( ˆ IV) ' ' '
cov (zx)
When IV is Biased
β
Y X
θ
λ
Z
cov (zy) %
E( ˆ IV) ' ' ' %
cov (zx)
Why Is IV Unbiased?
yn' xn%gn
j z n y n ' j z n x n %j z n g n
zy
ˆ 'j n n
IV
j z nx n
Yn = " + $Xn + gn
instrument Zn
Xn = 8 + 2Zn + µn
Example
Step 1: Regress
Calculate
(op. cost) ' ˆ % ˆ (gas price)
Step 2: Regress
2SLS Interpretation of IV
Yn = " + $Xn + gn
Xn = 8 + 2Zn + µn
________ ____
| |
| |
uncorrelated correlated
with g with g
(
Yn ' % X̂ % gn
X̂ n ' ˆ % ˆ zn
(
gn ' gn % µ̂ n
Because income and family size enter directly, they are not
part of g and hence are not correlated with g .
2SLS
Step 1:
x n ' z n % gn
cov (zx)
ˆ
OLS '
var (z)
x̂ n ' ˆ OLSzn
Step 2:
yn ' x̂ n % gn
cov (x̂y)
ˆ
2SLS '
var (x̂)
cov ( ˆ OLSzy) ˆ
OLS cov (zy)
ˆ
2SLS ' '
var ( ˆ OLSz) ˆ2
OLS var (z)
TSP Commands
2. 2SLS implicitly
3. IV
inst y c,x invr c,z;