st: Re: other ways in dealing with endogeneity other than IV?

[Kit Baum <baum@bc.edu>]

In Austin's excellent Stata Journal (7:4, 2007) article, he discusses  
the usefulness of fixed effects models to deal with a certain kind of  
'endogeneity', which he describes as correlation between regressor  
and error. It is true that in the model

y_it = X_it b + u_it

on panel data, with X strictly exogenous, there will be an  
endogeneity problem if there is unobserved heterogeneity that depends  
only on who you are (only on i). This arises because the true DGP is

y_it = X_it b + [ a_i + u_it]

and if a_i (individual-specific characteristics) are correlated with  
observed X's, the error term is correlated with the regressors and  
OLS is inconsistent. That can be dealt with, as he discusses, with  
fixed effects, expressing a_i as a parameter to be estimated using  
individual-specific dummy variables or the within transformation, a  
la -xtreg, fe- or -areg-.

BUT if the original assumption that X is exogenous -- uncorrelated  
with u -- is not appropriate, then there is conventional endogeneity  
in the equation as well as unobserved heterogeneity. Fixed effects  
will deal with the latter, but not the former, and fixed effects will  
be just as inconsistent as pooled OLS. That is the point I was  
making. In that circumstance you need an IV fixed-effects estimator  
such as that implemented by -xtivreg, fe- or -xtivreg2, fe-, or an  
estimator implementing the first difference transformation with IV (- 
xtivreg, fd- or -xtivreg2, fd-).


Kit Baum, Boston College Economics and DIW Berlin
http://ideas.repec.org/e/pba1.html
An Introduction to Modern Econometrics Using Stata:
http://www.stata-press.com/books/imeus.html


On May 7, 2008, at 02:33 , Austin wrote:

> Kit et al.--
> A fixed-effects model deals with one very specific type of endogeneity
> due to omitted variables that vary only across groups in i() and not
> within.  Hence the discussion of -xtreg- in
> http://www.stata-journal.com/article.html?article=st0136
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