Measurement Errors in Investment Equations

52 Pages Posted: 23 Mar 2010 Last revised: 6 Apr 2010

See all articles by Heitor Almeida

Heitor Almeida

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Antonio F. Galvao

University of Illinois at Urbana-Champaign - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: March 16, 2010

Abstract

We use Monte Carlo simulations and real data to assess the performance of alternative methods that deal with measurement error in investment equations. Our experiments show that individual-fixed effects, error heteroscedasticity, and data skewness severely affect the performance and reliability of methods found in the literature. In particular, estimators that use higher-order moments are shown to return biased coefficients for (both) mismeasured and perfectly-measured regressors. These estimators are also very inefficient. Instrumental variables-type estimators are more robust and efficient, although they require restrictive assumptions. We estimate empirical investment models using alternative methods. Real-world investment data contain firm-fixed effects and heteroscedasticity, causing high-order moments estimators to deliver coefficients that are unstable across different specifications and not economically meaningful. Instrumental variables methods yield estimates that are robust and seem to conform to theoretical priors. Our analysis provides guidance for dealing with the problem of measurement error under circumstances empirical researchers are likely to find in practice.

Keywords: Investment equations, measurement error, Monte Carlo simulations, instrumental variables, GMM

JEL Classification: G31, C23

Suggested Citation

Almeida, Heitor and Campello, Murillo and Galvao, Antonio F., Measurement Errors in Investment Equations (March 16, 2010). Available at SSRN: https://ssrn.com/abstract=1572804 or http://dx.doi.org/10.2139/ssrn.1572804

Heitor Almeida

University of Illinois at Urbana-Champaign ( email )

515 East Gregory Drive
4037 BIF
Champaign, IL 61820
United States
217-3332704 (Phone)

HOME PAGE: http://www.business.illinois.edu/FacultyProfile/faculty_profile.aspx?ID=11357

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Murillo Campello (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

114 East Avenue
369 Sage Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138

Antonio F. Galvao

University of Illinois at Urbana-Champaign - Department of Economics ( email )

601 E John St
Champaign, IL 61820
United States

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