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st: re: overidentifying restrictions

From   Kit Baum <>
Subject   st: re: overidentifying restrictions
Date   Tue, 28 Jul 2009 06:42:06 -0400

Erasmo said

I hope you don't mind if I ask for an additional clarification. I thought that if instruments are orthogonal to epsilon (1), then it must be that they (the instruments) only inderectly influence y (2). That is, it seems to me that (2) is absorbed by (1), but it is very likely that I am missing the point.

Well, in the classical (OLS) regression model y = X b + u, the X variables are orthogonal to u, but they certainly influence y directly... so I don't see how a statement of orthogonality conditions on [(X Z) vs u] tells me that X belongs in the equation but Z does not. That is the problem of specification of the model. What we do know is that if some of the Zs are really Xs, and we leave them out of the estimated model, then their presence in the error term will likely show up in an overid test. (There is a somewhat implausible textbook case relating to omitted variables being orthogonal to omitted regressors, but that is unlikely to occur in real data).

Kit Baum   |   Boston College Economics & DIW Berlin   |
An Introduction to Stata Programming |
   An Introduction to Modern Econometrics Using Stata  |

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