RE: st: RE: Testing for instrument relevance and overidentification when the endogeneous variable is used in interaction terms

["Schaffer, Mark E" <M.E.Schaffer@hw.ac.uk>]

Jason,

> -----Original Message-----
> From: owner-statalist@hsphsun2.harvard.edu [mailto:owner- 
> statalist@hsphsun2.harvard.edu] On Behalf Of Jason Wichert
> Sent: 07 June 2013 12:35
> To: statalist@hsphsun2.harvard.edu
> Subject: Re: st: RE: Testing for instrument relevance and 
> overidentification when the endogeneous variable is used in 
> interaction terms
> 
> Mark,
> 
> Alright, that’s a relief. However, as promised (threatened?), I’ve 
> come up with some additional questions.
> 
> Isn’t the approach discussed most recently, i.e.
> 
> [1] ivreg2 y controls ex1 ex2 (en en_ex1 en_ex2 = enhat enhat_ex1 
> enhat_ex2)
>  (notation: ex1, ex2 = exogenous variables; en = endogenous variable; 
> z1, z2 = instruments for en)
> 
> in effect the same as rolling additional FSR’s (for the lack of 
> appropriate word) of the type
> 
> [2] regress en_ex1 controls ex1 ex2 enhat enhat_ex1
> 
> and
> 
> [3] regress en_ex2 controls ex1 ex2 enhat enhat_ex2
> 
> just with the additional/unnecessary respective instruments enhat_ex2 
> and
> enhat_ex1 in [2] and [3]?

I'm not sure (to be honest I've lost track of what is what).  You have equivalence with straight IV only if enhat_ex2 and enhat_ex1 are "unnecessary" because of perfect collinearity.  If you don't have perfect collinearity, and your IVs enhat, enhat_ex1 and enhat_ex2 are linear combinations of a longer list of things you think are exogenous, then you may have taken a step towards solving your problem because you have a smaller number of IVs (created by collapsing your full set of IVs into a smaller number of linear combinations).

As for the control function approach, that looks promising.  But maybe others on the list who use it have something to contribute here....

--Mark

> 
> While tedious and error-prone, following approach [1] doesn’t seem to “cure”
> the 2SLS test results, since I’m again instrumenting several 
> interaction terms by instruments weakly or un-correlated to the 
> instrumented terms (such as
> enhat_ex2 to ex1_en).
> 
> I read up on the “control function approach” suggested largely by 
> Wooldridge as an alternative, which he mentions in his 2002 version of 
> "Econometric analysis of cross section and panel data", a comment he 
> made in http://www.stata.com/statalist/archive/2011-03/msg00187.html , 
> as well as lecture slides I found online ( 
> http://www.eief.it/files/2011/10/slides_3_controlfuncs.pdf ). In the 
> latter, regarding to forbidden regressions and the control function 
> approach, he states “Danger with plugging in fitted values for y2 [the 
> endog. variable] is that one might be tempted to plug y2_hat into nonlinear functions, say (y2)^2 or y2_z1.
> This does not result in consistent estimation of the scaled parameters 
> or the partial effects.
> If we believe y2 has a linear RF with additive normal error 
> independent of z, the addition of v2_hat solves the endogeneity 
> problem *regardless* of how y2 appears.”
> 
> I’m considering to run such sole control function, predict the 
> residual, and incorporate in my OLS or what otherwise might be the 
> second stage of my 2SLS, with all the interaction terms (for the sake 
> of brevity, leaving quadratic terms of ex1 and ex2 aside), i.e.
> 
> regress en ex1 ex2 z1 z2 en1_z1 en1_z2 en2_z1 en2_z2
> 
> predict en_resid, resid
> 
> regress y ex1 ex2 en ex1_en ex2_en en_resid
> 
> This almost sounds too simple to be true to my naïve understanding of 
> the matter. So again, any feedback is highly appreciated.
> 
> Jason
> 
> 
> On Thu, Jun 6, 2013 at 10:26 PM, Schaffer, Mark E 
> <M.E.Schaffer@hw.ac.uk>
> wrote:
> > Jason,
> >
> > I was just generalizing - in your case there's only one preliminary 
> > regression,
> namely the one to get en_hat.
> >
> > Cheers,
> > Mark
> >
> >> -----Original Message-----
> >> From: owner-statalist@hsphsun2.harvard.edu [mailto:owner- 
> >> statalist@hsphsun2.harvard.edu] On Behalf Of Jason Wichert
> >> Sent: 06 June 2013 13:27
> >> To: statalist@hsphsun2.harvard.edu
> >> Subject: Re: st: RE: Testing for instrument relevance and 
> >> overidentification when the endogeneous variable is used in 
> >> interaction terms
> >>
> >> Mark,
> >>
> >> As multiple times before, thank you very much. However, you got me 
> >> a little confused with your statement “when you do the various 
> >> preliminary regressions” for getting fitted values. My 
> >> understanding was to solely get fitted values for my one truly 
> >> endogenous variable “en” from a single regression of “en” on all 
> >> included and excluded instruments (including ex1 and ex2, which are 
> >> to be interacted with “en”), to then form interactions of the 
> >> fitted/predicted values of “en” with ex1 and ex2, and ultimately 
> >> use those interactions (enhat, enhat_ex1, enhat_ex2) as instruments for en, en_ex1, en_ex2 in ivreg2.
> >> Apologies for asking again, but considering the difficulties 
> >> encountered and discussed so far, I want to make sure to follow the 
> >> correct procedure and stay away from any territory of forbidden 
> >> regressions
> and the likes.
> >>
> >> I’m afraid you and statalist won’t have heard from me and this 
> >> issue for the last time just yet.
> >>
> >> Kind regards,
> >> Jason
> >>
> >> On Thu, Jun 6, 2013 at 1:30 PM, Schaffer, Mark E 
> >> <M.E.Schaffer@hw.ac.uk>
> >> wrote:
> >> > Jason,
> >> >
> >> > I think that's right.  If it's the procedure I think you have in 
> >> > mind, the
> >> intuition behind it is that you are fairly confident that your 
> >> included and excluded instruments (ex and z in your notation, I
> >> think) in various forms (levels, squares, interactions with each 
> >> other, etc.)
> are all valid instruments.
> >> When you do the various preliminary regressions ("first stage" is 
> >> probably the wrong term - it's not the same thing as the 1st stage 
> >> of
> >> 2SLS) and get fitted values, those fitted values are linear 
> >> combinations of various valid instruments.  Since they're linear 
> >> combinations of exogenous things, they're also exogenous and can be 
> >> used as excluded instruments or interacted with other exogenous 
> >> variables to get still more instruments.  The reason to use linear 
> >> combinations instead of the variables separately is to avoid the 
> >> various problems that come from using a large number of excluded
> instruments.  Of course, there's a lot of other stuff you also have to 
> believe for this to !
> >> >  work, but that's your call ... good luck!
> >> >
> >> > HTH,
> >> > Mark

<snip - getting too long for the list server>



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