Granular Instrumental Variables

97 Pages Posted: 15 Apr 2019 Last revised: 8 Jul 2021

See all articles by Xavier Gabaix

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Ralph S. J. Koijen

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: July 7, 2021

Abstract

We propose a new way to construct instruments in a broad class of economic environments: “granular instrumental variables” (GIVs). In the economies we study, a few large firms, industries or countries account for an important share of economic activity. As the idiosyncratic shocks from these large players affect aggregate outcomes, they are valid and often powerful instruments. We provide a methodology to extract idiosyncratic shocks from the data in order to create GIVs, which are size-weighted sums of idiosyncratic shocks. These GIVs allow us to then estimate parameters of interest, including causal elasticities and multipliers.
We first illustrate the idea in a basic supply and demand framework: we achieve a novel identification of both supply and demand elasticities based on idiosyncratic shocks to either supply or demand. We then show how the procedure can be enriched to work in many sit- uations. We provide illustrations of the procedure with two applications. First, we measure how “sovereign yield shocks” transmit across countries in the Eurozone. Second, we estimate short-term supply and demand multipliers and elasticities in the oil market. Our estimates match existing ones that use more complex and labor-intensive (e.g., narrative) methods. We sketch how GIVs could be useful to estimate a host of other causal parameters in economics.

Suggested Citation

Gabaix, Xavier and Koijen, Ralph S. J., Granular Instrumental Variables (July 7, 2021). Available at SSRN: https://ssrn.com/abstract=3368612 or http://dx.doi.org/10.2139/ssrn.3368612

Xavier Gabaix

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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European Corporate Governance Institute (ECGI)

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Ralph S. J. Koijen (Contact Author)

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/ralph.koijen/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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