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Introductory EconometricsIntuition, Proof, and Practice$
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Jeffrey Zax

Print publication date: 2011

Print ISBN-13: 9780804772624

Published to Stanford Scholarship Online: June 2013

DOI: 10.11126/stanford/9780804772624.001.0001

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What If the Disturbances and the Explanatory Variables Are Related?

What If the Disturbances and the Explanatory Variables Are Related?

Chapter:
(p.363) Chapter 10 What If the Disturbances and the Explanatory Variables Are Related?
Source:
Introductory Econometrics
Publisher:
Stanford University Press
DOI:10.11126/stanford/9780804772624.003.0010

This chapter deals with the possibility that the disturbances and the explanatory variables are related. This problem is called endogeneity or simultaneity. In this case, ordinary least squares (OLS) estimators are biased and inconsistent. Worse, they are unsalvageable. The solution can be thought of as a two-step procedure consisting of two applications of OLS. For this reason, it is often called two-stage least squares. It is also called, more generally, instrumental variables. This technique provides estimators that are not unbiased, only consistent. Therefore, the success of the solution is much more sensitive to the size of the sample than it was in the previous two chapters.

Keywords:   regression analysis, endogeneity, simultaneity, ordinary least squares, two-state least squares, estimators

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