Introduction to Econometrics
Chapter 6 : Endogeneity and instrumental variables
By Lund University
Throughout the course so far, we have assumed that the explanatory variables are exogenous. This is the most critical assumption in econometrics. In this chapter we will look at cases when explanatory variables cannot be expected to be exogenous (we then say that they are endogenous). We will also look at the consequence of econometric analysis with endogenous variables. Specifically, we will look at misspecification of our model, errors in variables and the simultaneity problem. When we have endogenous variables, we can sometimes find instruments for them, variables which are correlated with our endogenous variable but not with the error term. This opens for the possibility of consistently estimate the parameters in our model using the instrumental variable estimator and the generalized instrumental variable estimator.