New Exogeneity Tests & Causal Paths

Abstract

Statistically dependent X and Y have conditional density f(Y|X) asymmetrically different from unconditional f(Y). Theorem 1 com- pares two flipped kernel regressions to derive necessary conditions for causal path X --> Y and exogeneity meaning that X is self-driven. Hausman-Wu's indirect exogeneity test diagnoses a disease (endogeneity) by showing that instrumental variables (IV) estimator remedy 'works.' Instead, a unanimity index-based test aggregates evidence from four orders of stochastic dominance and new asymmetric partial correlation coefficients to determine the direction and strength of causal and exogenous variables. A simulation supports our decision rules. An illustration identifies exogenous variables which can help predict US economic recession.

Keywords: Kernel Regression, stochastic dominance, statistical independence, recesion forecasting

JEL Classification: C18, C36, C54, E37