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st: RE: Economic Intuition of IV estimates

From   "Vincent, David" <>
To   "" <>
Subject   st: RE: Economic Intuition of IV estimates
Date   Fri, 12 Feb 2010 11:26:07 +0000


Most linear economic models describe a causal relationship, where the parameters 'b' are interpreted as the causal-effects of the x-variables on the expected value of y. So in your model, if b=0.5, then an increase in tangible assets of 1 would lead to an expected rise in the leverage of 0.5. The OLS estimator will consistently estimate the expected leverage given tangible assets, or at least provide a best linear approximation, but will not be a consistent estimator for the causal parameter 'b' when the error term is correlated with the rhs variable. In this case we use IV/2SLS with instruments that are correalted with tangible assets but  uncorrelated with the error term to identify 'b'. For more info, see any econometrics text (verbeek/Greene etc). 


David Vincent
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Hewlett-Packard Limited
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-----Original Message-----
From: [] On Behalf Of Erasmo Giambona
Sent: 12 February 2010 11:04
To: statalist
Subject: st: Economic Intuition of IV estimates

Dear Statalist,

I am trying to gain more economic intuition on IV estimation. I am
estimating the following model using a panel dataset of firm-year

Leverage Ratio = a + b*Tangible Assets+e.

Suppose Tangible Assets is endogenous. My instrument is a proxy for
Demand of Tangible Assets (Instrument1). Question 1) If I estimate the
model using 2SLS, how do I interpret "b"? In particular, is it
possible to state that "b" tells me how Demand of Tangible Assets
affects the leverage ratio? Question 2) Suppose I have an additional
instrument (e.g., Firm Age - Instrument 2) and let's assume this in
unrelated to Leverage Ratio. If I estimate the model again using both
Instruments, it seems that "b" does not tell me anymore ONLY how
Demand of Tangible Assets affects the leverage ratio. Is my
interpretation correct?

Any thoughts on the issue is highly appreciated,

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