Small Sample Performance of TSLS

Empirical Example

Small Sample Peformance of TSLS

Empirical Example
Walter Sosa-Escudero
Econ 507. Econometric Analysis. Spring 2009

March 8, 2009

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

Small sample performance of TSLS

A collection of statements (no proofs).

Weak instruments: instruments poorly correlated with the
endogenous regressions.
When instruments are weak and when p is too large with
respect to K: TSLS is biased towards the plim of the OLS
estimator.
For a fixed sample size, more instruments bias TSLS in the
direction of the OLS estimator.
When a single instrument is valid, the just identified IV
estimator is median unbiased.

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

A Montecarlo Exploration
Source: Angrist and Pischke (2009, Mostly Harmless Econometrics, pp.
210-212).

Model
yi = xi + i
xi =

p
X

j zij + i

j=1

= 1, 1 = 0.1, j = 0, j = 2, . . . , p.



 
i 
0
1
ZN
,
i 
0
0.8

0.8
1



Which parameter creates the endogeneity of x?

Which are the valid instruments?
Which parameter controls weakeness of instrument?
Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

Montecarlo experiment: choose a set of parameters, simulate

(i , i ) with a random number generator, create artificial data,
compute TSLS, OLS as if (i , i ) is not observed, repeat many
times.
Repeat experiment for alternative configurations of the parameters.
This produces simulated distributions of the estimators used.

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

Two instruments, one valid. N = 1000

OLS severly biased. F in the first stage is 11.1. Recall 0 = 1.

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

20 instruments, one valid. N = 1000

Now TSLS is very biased. F in the first stage is 1.51

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

Now 1 = 0, 20 invalid instruments.

Now all are severly shifted. F in the first stage is 1.0!!!

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

Empirical Example

Source: Mroz, in Wooldridge (2002).

Explanied variable: lwage (log wages)
Explanatory variables: education, experience and its square.
Data: 428 married women.
Goal: measure returns to education.
Problem: education is likely to be endogenous.
Instruments: father, mother and husband education. Are
them likely to be valid? Under what circumstances they are
not valid instruments.

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

reg lwage exper expersq educ

lwage |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------exper |
.0415665
.0131752
3.15
0.002
.0156697
.0674633
expersq | -.0008112
.0003932
-2.06
0.040
-.0015841
-.0000382
educ |
.1074896
.0141465
7.60
0.000
.0796837
.1352956
_cons | -.5220406
.1986321
-2.63
0.009
-.9124667
-.1316144
-----------------------------------------------------------------------------ivreg lwage exper expersq (educ = motheduc fatheduc huseduc)
lwage |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------educ |
.0803918
.021774
3.69
0.000
.0375934
.1231901
exper |
.0430973
.0132649
3.25
0.001
.0170242
.0691704
expersq | -.0008628
.0003962
-2.18
0.030
-.0016415
-.0000841
_cons | -.1868572
.2853959
-0.65
0.513
-.7478242
.3741097

Careful: in our jargon there are 4 explanatory variables (educ, exper, expersq
and the intercept) and 6 instruments (exper, expersq, a vector of ones,
motheduc, fatheduc, huseduc).

Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example

Small Sample Performance of TSLS

Empirical Example

Exploring instrument validity: the first stage regression

. reg educ exper expersq motheduc fatheduc huseduc
Source |
SS
df
MS
-------------+-----------------------------Model | 1820.49038
5 364.098077
Residual | 2089.54946
747 2.79725496
-------------+-----------------------------Total | 3910.03984
752 5.19952106

Number of obs
F( 5,
747)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

753
130.16
0.0000
0.4656
0.4620
1.6725

-----------------------------------------------------------------------------educ |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------exper |
.0532406
.0218443
2.44
0.015
.0103571
.0961241
expersq | -.0007403
.000708
-1.05
0.296
-.0021303
.0006497
motheduc |
.130004
.0223789
5.81
0.000
.086071
.1739371
fatheduc |
.1013613
.0214423
4.73
0.000
.059267
.1434556
huseduc |
.3715645
.0220465
16.85
0.000
.3282839
.414845
_cons |
5.115778
.298017
17.17
0.000
4.530727
5.700828
-----------------------------------------------------------------------------. test motheduc fatheduc huseduc
F( 3,
747) = 209.33
Prob > F =
0.0000

In Stata 10, the ivregress command implements the heteroskedasticity robust, optimally weighted GMM
estimator.
Walter Sosa-Escudero

Small Sample Peformance of TSLS Empirical Example