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LN+13+Instrumental+Variables

LN+13+Instrumental+Variables - Empirical Methods II(API-202...

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Empirical Methods II (API-202) Kennedy School of Government Harvard University 1 Lecture Notes 13 Instrumental Variables I - INTRODUCTION Three important threats to internal validity (causal identification): 1) Omitted variable bias: a. Certain variable affects Y but is unobservable, so it cannot be included in the SR b. this variable is correlated with X 2) Reverse causality bias: X causes Y , Y causes X 3) Measurement error bias: X is measured with error These 3 problems each signify a violation of the zero conditional mean condition o i.e. E[u|X 1 ,X 2 ,…,X k ]=0 or simply E[u|X]=0 o roughly speaking: the error term cannot be correlated with any RHS variable o Cannot infer causality from SR if zero conditional mean condition doesn’t hold Instrumental variables (IV) is a method used to try to eliminate bias from all three sources in order to obtain unbiased estimates.
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