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2. There may be good reasons to suspect a failure of the zero-conditional-mean assumption. Turing to
IV or Generalized Method of Moments (GMM) for the sake of consistency must be balanced against
the inevitable loss of efficiency. The asymptotic variance of the IV estimator is always larger and
sometimes much larger than the OLS estimates.
3. GMM can have very poor small sample properties and if we are working with a small sample, it is
probably better to work with OLS instead.
4. Loss of efficiency is worth it and can be made up for, in part, by getting a larger sample.
5. The Hausman test is essentially a test of whether the loss in efficiency is worth removing the bias and
inconsistency of the OLS estimators.
6. The question is whether we can just treat the endogenous variables as if they were exogenous and not
worry about the correlation with the error.
Test statistic
1. The Hausman test involves fitting the model by both IV and OLS and compares a weighted square of
the difference between the two β estimators.
2. The weights is simply the difference in the variances between the consistent (IV) estimator and the
efficient (OLS) estimator.
3. The test is given by
�
xy
β̂ ols
= � 2
x
�
ux
β̂ ols = β+ � 2
x
� � � 2
x σ2
var β̂ ols = σ2 � 2 = �
( x2 ) x2
P
where normally P ux = 0. But if β ols is biased, then it is not. For IV
x2
�
zy
β̂ IV = � 2
z
�
uz
β̂ IV = β+�
xz
� � � 2
z
var β̂ IV = σ2 � 2
( xz)
Next define
= β̂ IV − β̂ OLS
q̂
� 2
z σ2
var(β̂ IV ) − var(β̂ OLS ) = σ 2 � 2 − �
( xz) x2
�� � �
s2 z 2 x2
= � 2 � 2 −1
x ( xz)
Test statistic is � �2
β̂ IV − β̂ OLS
m=
var(β̂ OLS ) − var(β̂ IV )
10. Baum (2006) points out that the Hausman command often fails, producing a negative χ2 statistic
and that these tests are not fully consistent with each other and can give conflicting results.
11. See help(hausman) in Stata. From the Stat help file:
The assumption that one of the estimators is efficient (i.e., has minimal asymptotic vari-
ance) is a demanding one. It is violated, for instance, if your observations are clustered or
pre-weighted, or if your model is somehow misspecified. Moreover, even if the assumption
is satisfied, there may be a ”small sample” problem with the Hausman test [due to the
lack of positive definiteness ”in finite samples”,] i.e., in your application. If this is the case,
the Hausman test is undefined. Unfortunately, this is not a rare event. Stata supports a
generalized Hausman test, suet that overcomes both of these problems.
12. Note that Baum reports that this command does not support the ivreg estimator.”
2
Field Technique
1. Similar to a test for measurement error
2. If there is no simultaneity, then OLS should generate efficient and consistent parameter estimates.
3. IV consistent but inefficient
4. Consider SD example again
q = αp + u
where q is quantity supplied. Income and costs are exogenous and therefore good instruments.
5. The null of no simultaneity says that p and u are uncorrelated.
p̂ = π1 y + π2 C
p = p̂ + v̂
7. These πs can be estimated using OLS without violating assumptions of standard linear regression
model.
8. p is the population parameter and is efficiently and consistently estimated.
9. Substitute this into the above equation
q = αp̂ + αv̂ + u
11. Under null of no simultaneity, correlation between residuals, v, and teh error term will be zero as
sample size goes large.
12. Since we already know that that the correlation between p̂ and the error is zero, this will give a
consistent estimate of alpha.
13. However, δ will be inefficiently estimated because a degree of freedom is used up.
14. This suggests a simple test. Rewrite eqn 2 as
q = αp + (δ − α)v̂ + u (2)