Challenges and limitations of instrumental variable analysis
Instrumental variables analysis is a powerful tool in econometrics and statistics for estimating causal effects when dealing with endogeneity issues. Despite its usefulness, instrumental variable analysis comes with several challenges and limitations that you must carefully address. This discussion delves into common pitfalls such as weak instrumental variables, measurement errors in instrumental variables, and the nuances of interpreting instrumental variable estimates.
Weak instrumental variables
An instrumental variable is considered weak if its correlation with the endogenous explanatory variable it aims to instrument is minimal. Such weak instrumental variables compromise the instrumental variable estimation, yielding biased results akin to those of ordinary least squares (OLS) in endogeneity scenarios. Furthermore, they elevate the instrumental variable estimator’s variance, diminishing its precision.
...
