Week 14 - Instrumental Variables

Chapter 12: Instrumental Variables Regression

SW 12.1 The IV Estimator with a Single Regressor and a Single Instrument

Make sure you understand the difference between endogeneous variables (correlated with error term $u$) and exogenous variables (not correlated). The textbook covers two conditions for a valid instrument: relevance ($corr(Z_i,X_i)\ne 0$) and exogeneity ($corr(Z_i,u_i)=0$). To make the assumptions of IV explicit, I prefer to include an exclusion assumption: that the instrument $Z$ affects $Y$ only through $X$. If you come away from this section with the right vocabulary and a good intuition of what an instrument “does,” then you’re in good shape!

I find the derivation (in the text and video) helpful, but it’s not something I’d test you on.

SW 12.2 The General IV Regression Model

Now we get a bit technical. The key important things here are the understanding of two-stage least squares - what it is and how it works, plus a good understanding of those assumptions.

SW 12.3 Checking Instrument Validity

Make sure you know what a weak instrument is, why it’s a problem, and how we identify it. Make sure you understand the logic behind whether an instrument violates it’s exogeneity assumption.

pic.twitter.com/sb7hzO6dzZ

— Daniel Millimet 🇺🇦 (@dlmillimet) December 3, 2021

Real footage of an economist checking whether his IV assumptions hold uppic.twitter.com/qK1EvB11En

— Khoa Vu (@KhoaVuUmn) August 19, 2021

Skip the test of overidentifying restrictions

SW 12.4-12.6 The Other Stuff

Good content and examples, but nothing new.