Granular Instrumental Variables

84 Pages Posted: 15 Apr 2019 Last revised: 30 Jan 2020

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)

Date Written: January 29, 2020

Abstract

In many settings, economists have few instruments with which to investigate causal relations. We propose a general way to construct new instruments: “granular instrumental variables” (GIVs). In the economies we study, a few large firms, industries or countries account for a 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.

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 situations. We provide illustrations of the procedure with two applications. First, we measure how “sovereign yield shocks” spill over to other countries in the Eurozone. Second, we estimate short-term supply and demand elasticities in the oil market. Our estimates match existing estimates that use much 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 (January 29, 2020). 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)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Ralph S. J. Koijen (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
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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