Granular Instrumental Variables

Abstract

We develop a new method to construct instruments in a broad class of economic environments. In the economies we study, a few large firms, industries or countries account for an important share of economic activity. Idiosyncratic shocks to these large players significantly affect aggregate outcomes and are valid instruments. We provide a methodology to extract these idiosyncratic shocks to create “granular instrumental variables” (GIVs), which are size-weighted sums of idiosyncratic shocks. We show how GIVs enable us to estimate causal parameters, such as elasticities and multipliers, and are applicable in a broad range of empirically relevant settings.