GMM Estimation with Non‐Causal Instruments
University of Helsinki - Department of Political and Economic Studies
University of Helsinki - Department of Statistics
Oxford Bulletin of Economics and Statistics, Vol. 73, Issue 5, pp. 581-592, 2011
This note provides a warning against careless use of the generalized method of moments (GMM) with time series data. We show that if time series follow non‐causal autoregressive processes, their lags are not valid instruments, and the GMM estimator is inconsistent. Moreover, endogeneity of the instruments may not be revealed by the J‐test of overidentifying restrictions that may be inconsistent and has, in general, low finite‐sample power. Our explicit results pertain to a simple linear regression, but they can easily be generalized. Our empirical results indicate that non‐causality is quite common among economic variables, making these problems highly relevant.
Number of Pages in PDF File: 12
JEL Classification: C12, C22, C51Accepted Paper Series
Date posted: September 16, 2011
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