# What makes a valid instrumental variable?

## What makes a valid instrumental variable?

The three main conditions that define an instrumental variable are: (i) Z has a casual effect on X, (ii) Z affects the outcome variable Y only through X (Z does not have a direct influence on Y which is referred to as the exclusion restriction), and (iii) There is no confounding for the effect of Z on Y.

### What is excluded instrument?

The (L+M) variables in zi are called instruments. The L additional variables in zi which are not included in xi are called excluded instruments. Sometimes only those L variables are called instruments.

#### How many assumptions does an instrumental variable have?

Conclusions. Three basic assumptions for the instrumental variable method have been characterised in the literature, but the fourth identifying assumption of monotonicity has received less attention.

What is an instrumental variable example?

An example of instrumental variables is when wages and education jointly depend on ability which is not directly observable, but we can use available test scores to proxy for ability. …

How do instrumental variables work?

The idea behind instrumental variables is that the changes in treatment that are caused by the instrument are unconfounded (since changes in the instrument will change the treatment but not the outcome or confounders) and can thus be used to estimate the treatment effect (among those individuals who are influenced by …

## What is instrumental variable approach?

In statistics, econometrics, epidemiology and related disciplines, the method of instrumental variables (IV) is used to estimate causal relationships when controlled experiments are not feasible or when a treatment is not successfully delivered to every unit in a randomized experiment.

### How do you do instrumental variables?

Using an instrumental variable to identify the hidden (unobserved) correlation allows you to see the true correlation between the explanatory variable and response variable, Y. Z is correlated with the explanatory variable (X) and uncorrelated with the error term, ε, (What is ε?) in the equation: Y = Xβ + ε.

#### What are weak instruments?

Weak instruments—instruments that are only marginally valid—can cause many problems, including: Biased estimates for independent variables, Hypothesis tests with large size distortions (Stock & Yogo, 2002)

What is a strong instrumental variable?

An instrumental variable (sometimes called an “instrument” variable) is a third variable, Z, used in regression analysis when you have endogenous variables—variables that are influenced by other variables in the model. In other words, you use it to account for unexpected behavior between variables.

What is an instrumental variable analysis?

## How do you choose a good instrumental variable?

You certainly can choose candidate instruments “through theoretical considerations or evidence found in past research”. Then a simple check is to compute their linear correlation with the suspected endogenous variable, and their linear correlation with the dependent variable.

### How do you test for weak instruments?

Use the F-statistic to test for the significance of excluded instruments. If the first-stage F-statistic is smaller than 10, this indicates the presence of a weak instrument. For a scalar regressor (x) and scalar instrument (z), a small r squared (when x is regressed on z) indicates a weak instrument.

#### What is a weak IV instrument?

In instrumental variables (IV) regression, the instruments are called weak if their correlation with the endogenous regressors, conditional on any controls, ∗Andrews and Stock, Department of Economics, Harvard University, Cambridge, MA, 02138.

What is the method of instrumental variable?

What is instrumental variables analysis?

## Why is 2SLS biased?

With weak instruments 2SLS is biased towards OLS. The bias will tend to be worse when there are many overidentifying restrictions (many instruments compared to endogenous regressors).

### What is a weak instrumental variable?

In instrumental variables (IV) regression, the instruments are called weak if their correlation with the endogenous regressors, conditional on any controls, is close to zero.

#### What is the exclusion restriction instrumental variable?

When researchers employ instrumental variables, they rely on two primary assumptions. As a result, exclusion restrictions are considered observed variables that impact treatment assignment, but not the outcome of interest conditional on treatment assignment.

Is 2SLS estimator unbiased?

As is well known, the conventional two-stage least squares (2SLS) estimator may be severely biased in overidentified models with weak instruments. (2015), but none of the resulting feasible estimators is unbiased either in finite samples or under weak instrument asymptotics.

How can you tell if an instrumental variable is weak?