A Practical Guide to Weak Instruments

Michael Keane (m.keane@unsw.edu.au) and Timothy Neal

No 2021-05d, Discussion Papers from School of Economics, The University of New South Wales

Abstract: We provide a simple survey of the weak IV literature, aimed at giving practical advice to applied researchers. It is well-known that 2SLS has poor properties if instruments are exogenous but weak. We clarify these properties, explain weak instrument tests, and examine how behavior of 2SLS estimates and test statistics depend on instrument strength. A common standard for acceptably strong instruments is a ï¬ rst-stage F of 10, which renders two-tailed t-test size distortion modest. However, we show that 2SLS standard errors tend to be artiï¬ cially small in samples where the estimate is most contaminated by the OLS bias. This means the t-test has inflated power to detect false positive effects when the OLS bias is positive. Surprisingly, this problem persists even if the ï¬ rst-stage F is in the thousands. Robust tests like Anderson-Rubin perform better, and should be used in lieu of the t-test even with strong instruments. In many realistic settings a ï¬ rst-stage F well above 10 may be necessary to give high conï¬ dence that 2SLS will outperform OLS. For example, in the archetypal application of estimating returns to education, we argue one needs F of at least 50.

Keywords: Instrumental variables; weak instruments; 2SLS; endogeneity; F-test; size distortion; Anderson-Rubin test; conditional LR test; Fuller; JIVE (search for similar items in EconPapers)
Pages: 52 pages
Date: 2022-06
References: Add references at CitEc
Citations: View citations in EconPapers (9)

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Journal Article: A Practical Guide to Weak Instruments (2024)
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