Explain the purpose of an instrumental variable regression m

Explain the purpose of an instrumental variable regression model.

Solution

A major complication that is emphasized in microeconometrics is the possibility of inconsistent parameter estimation due to endogenous regressors. Then regression estimates measure only the magnitude of association, rather than the magnitude and direction of causation which is needed for policy analysis. The instrumental variables estimator provides a way to nonetheless obtain consistent parameter estimates. This method, widely used in econometrics and rarely used elsewhere, is conceptually difcult and easily misused. We provide a lengthy expository treatment that denes an instrumental variable and explains how the instrumental variables method works in a simple setting. 4