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G604, BLP Lectures

G604, BLP Lectures. Spring 2006, 2 March 2006 Eric Rasmusen, erasmuse@Indiana.edu. GMM in canned programs. Just like instrumental variables. You say, in SAS or STATA or whatever, that you are estimating REGRESS: Y X1 X2 X3 and then you say INSTRUMENT: X2 X3 Z1 Z2 Z3

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G604, BLP Lectures

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  1. G604, BLP Lectures Spring 2006, 2 March 2006 Eric Rasmusen, erasmuse@Indiana.edu

  2. GMM in canned programs Just like instrumental variables. You say, in SAS or STATA or whatever, that you are estimating REGRESS: Y X1 X2 X3 and then you say INSTRUMENT: X2 X3 Z1 Z2 Z3 This uses Z2, Z2, Z3 to instrument for X1 and correct for heteroskedasticity. The package calculates the variance-covariance weighting matrix for you.

  3. From Wooldridge. Log(wage) is the dependent variable (hourly wage). The instrument, neare4, is a man’s distance from a 4-year college when he was 16. An extra year of education is worth 3.7% more for a black man than a white man. The difference between 2SLS and GMM is the weighting matrix.

  4. GMM Benefit • 1. You can add all kinds of crazy instruments to improve your estimates • 2. But the weighting matrix means that the additional effect of bad instruments is slight • 3. And also that if they are correlated with the other instruments the effect is slight • (you get heteroskedasticity correction too, but you can get that in other ways)

  5. Dangers of GMM • The crazy instruments can hurt you in small samples (e.g., real samples), because of accidental correlations • You can do data-mining searches for crazy instruments

  6. Estimating causes of lawyer income Taxes-paid = Experience, Talent, GDP/lawyer, Lawsuits/lawyer The first three variables are for a given lawyer, the last two are for the prefecture in which he lives. What is wrong with this regression?

  7. Estimating causes of lawyer income Taxes-paid = Experience, Talent, GDP/capita, Lawsuits/capita GDP/capita comes in *negative*. Lawyers in rich prefectures have lower incomes! Why? (IV with variables such as hospitals/capita and cars/capita as instrument)

  8. Estimating causes of lawyer income Taxes-paid = Experience, Talent, Lawyers in the prefecture, Lawsuits/capita (demand) Taxes-paid = Number of movie theaters/capita (IV with variables such as hospitals/capita and cars/capita as instrument)

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