Have Instrumental Variables Brought Us Closer to the Truth
Review of Corporate Finance Studies, Forthcoming
23 Pages Posted: 31 Jul 2017
Date Written: March 21, 2017
A survey of 255 papers that rely on the instrumental variable (IV) approach for identifying causal effects published in the "Big Three" finance journals reveals that IV estimates are larger than their corresponding uninstrumented estimates in about 80% of the studies, regardless of whether the potential endogeneity is expected to create a positive or negative bias based on economic reasoning. Moreover, the magnitude of the IV estimates is, on average, nine times of that of the uninstrumented estimates even when, a priori, the nature of endogeneity should already imply an upward bias of the uninstrumented estimates. This study provides several explanations to this seeming puzzle of "implausibly large" IV estimates in finance research, and proposes best practices for identication-conscientious researchers to produce work that, in the aggregate, will bring us closer to the truth.
Keywords: identification; instrumental variables
JEL Classification: G30, C13
Suggested Citation: Suggested Citation