EP 520 - Winter 2021 Instructor: Archana Aggarwal

Mid-Semester Exam - 24th Match 2021

The exam is open book. You have two and a half hours to complete the exam. After that you must upload
and mail in your answer script within 15 minutes. Please read the questions carefully. Question 1 is 25%
(5, 20) of the grade, question 2 is 40% of the grade, while the last question is 35% (10, 10, 15) of the grade.
Your camera must remain on at all times. Calculators are permitted. Good luck.

1. (a) In the model

y1t = áx1t + äx2t + u1t
y2t = âx1t + ãx2t + u2t
With

(a)What can you say about the identifiability of the model?

(b) If you are given:
å x1t2 = 9, å x2t2 = 9, å x1tx2t = 1, åx1ty1t = 3, åx1ty2t = 2, åx2ty1t = 3, åx2ty2t = 4.
Find the BLUE of a, b, ä and g in part (a).

2. The following model jointly determines monthly child support payments and monthly visitation rights
for divorced couples with children:
S = á10 + ã12 V + ä11 FI + ä12 FM + ä13 D + å1 (1)
V = á20 + ã21 S + ä21 MM + ä22 D + å2 (2)

Assuming that children live with their mothers, so that fathers pay child support, equation 1 describes the
amount of child support paid for any given level of visitation rights and the other exogenous variables FI
(father’s income), FM (dummy variable indicating if father remarried), and D (miles currently between the
mother and father). Equation 2 describes visitation rights for a given amount of child support; MM is a
dummy variable indicating whether the mother is remarried.

(a) Discuss the identification status of each equation.

(b) Suppose that it is known a priori that ä13 = K ä11, where K is a known number. Discuss the identification
properties of the model after adding this restriction.
(c) Suppose instead that the term ä14 MI is added to the first equation, where MI measures mother’s income.
How does this alter the identification of the model?
(d) How would you estimate each equation using instrumental variables? State clearly the procedure to be
used and the instruments for each equation.

3. Consider the model

y1t = â12y2t + ã11x1t + u1t
y2t = â21y1t + ã22x2t + ã32x3t + u2t
where y1t and y2t are the endogenous variables and x1t, x2t, and x3t are the exogenous variables. You are
provided with the following information

(i) Derive the reduced form equations for the above model.
(ii) Estimate the reduced form parameters by OLS.
(iii) Estimate the structural equation parameters using instrumental variables.