12 Instrument variables

Question 1

properties of instrumental variables

Answer 1

Instrument relevance: Zi is correlated with the endogenous regressor Cov(Zi, Xi) != 0

Instrument exogeneity: Zi is uncorrelated with the error term Cov(Zi, ui) = 0 and has no direct effect on Yi

Question 2

instrumental variables regression

Answer 2

1) Regress Xi on Zi

2) Regress Yi on ^Xi