PW3

Question 1

What is an essential condition for an OLS estimator to be both unbiased and consistent

Answer 1

• The correlation between the explanatory variable and the error term must be zero

Question 2

When is a explanatory variable considered exogenous and endogenous

Answer 2

• Exogenous when cov(x,u) = 0 (x and u are uncorrelated)
• Endogenous when cov(x,u) =/ 0 (x and u are correlated

Question 3

Why might endogeneity occur in a model

Answer 3

• Measurement error (Mispecified variable)
• Omitted Variable Bias (Misspecified Model)
• Simultaneous Equations Bias

Question 4

What is one of the best ways of dealing with endogeneity

Answer 4

• The method of instrumental variables

Question 5

• What is an instrumental variable and what two assumptions do they satisfy

Answer 5

• Satisfies exogeneity: Z is uncorrelated with the error term u
• Satisfies relevance: Z is correlated with the endogenous variable x
• Z should not have a partial effect on y after x has been controlled for, and it should be related to the endogenous variable x