3. Endogeneity and instrumental variable

Question 1

Sources of endogeneity

Answer 1

1. Omitted variable bias
2. Simultaneity, reverse causality
3. measurment error

Question 2

Example

Consider:
lwage = B0 + B1educ + B2 ability + u

if ability is omitted, it stays in u and B1educ would be biased

Answer 2

workers with more education earn more
Beduc > 0
higher ability workers can earn more
Bability > 0
higher ability people typically have more education
delta > 0
Bias = Bability (delta > 0)
we will overestimate the effect of education
Education is endogenous is we do not control for ability

Question 3

Simultaneity

Answer 3

y and x are jointly determined/co-determined