Have Instrumental Variables Brought Us Closer to the Truth

Review of Corporate Finance Studies, Forthcoming

23 Pages Posted: 31 Jul 2017

See all articles by Wei Jiang

Wei Jiang

Columbia Business School - Finance and Economics; ECGI; NBER

Date Written: March 21, 2017

Abstract

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

Jiang, Wei, Have Instrumental Variables Brought Us Closer to the Truth (March 21, 2017). Review of Corporate Finance Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3009431

Wei Jiang (Contact Author)

Columbia Business School - Finance and Economics ( email )

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