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M320
Cross Section and Panel Data Econometrics
Topic 2: Generalized Method of Moments
Part II: The Linear Model
Dr. Melvyn Weeks
Faculty of Economics and Clare College
University of Cambridge
Outline
Outline I
Summary
GMM Estimators in the Linear Model
Notes
Outline
Notes
Readings
Cameron, A. C., and P. K. Trivedi (2005). Microeconometric
Methods and Applications. Cambridge University Press.
Chapter 6.
A. Colin Cameron and P.K. Trivedi. Microeconometrics Using
Stata. Stata Press, 2009. URL
http://www.stata.com/bookstore/mus.html
Hayashi, F. (2000) Econometrics. Princeton University Press,
Princeton.
Wooldridge, J. M. (2001). Applications of Generalized Method
of Moments Estimation, Journal of Economic Perspectives,
15(4), 87.100. 1
Outline
Notes
Outline
Notes
Road Map
In Generalized Method of Moments - Part II: The Linear Model,
we consider the gmm as a canonical estimator.
In doing this we show how ols, iv and 2sls are special cases of
the more general gmm estimator.
We show how just identified and over-identified models may be
represented as moment estimators. In the just-identified case we
also explicitly show that the gmm criterion function may be set to
zero, whereas in the over-identified case we minimise the distance
from zero.
We also provide some background material on the small-sample
properties of the iv and 2sls estimators.
Notes
Notes
OLS
Proposition
If E [X 0 ] = 0 ols is an unbiased estimator of .
Proof.
= (X 0 X )1 X 0 y
E [ ] = + E [(X 0 X )1 X 0 ]
= + (X 0 X ) 1 E [ X 0 ]
(1)
Notes
Proposition
If E [X 0 ] 6= 0 the ols estimator is biased and inconsistent
estimator of
Proof.
= (X 0 X )1 X 0 y
E [ ] = + E [(X 0 X )1 X 0 ]
= + E [(X 0 X )1 X 0 (X )] 6=
for E [|X ] = (X )
Question: why E [(X 0 X )1 X 0 (X )] cannot be factored, as in (1)?
The IV Estimator
Notes
= ( Z 0 X ) 1 Z 0 ( X + )
= ( Z 0 X ) 1 Z 0 X + ( Z 0 X ) 1 Z 0
bIV
Proposition
The IV estimator is biased in small samples.
Can we utilise the same sort of proof as used for the unbiasedness
of the ols estimator?
E [ bIV ] = E [(Z 0 X )1 Z 0 X + (Z 0 X )1 Z 0 ]
=
=
=
6=
(Z 0 X )1 Z 0 X + E X ,Z , [(Z 0 X )1 Z 0 ]
+ EX ,Z , [(Z 0 X )1 Z 0 ]
+ EX ,Z [(Z 0 X )1 [E [|Z , X ]]
+ (Z 0 X ) 1 E [ Z 0 ]
(2)
(3)
Notes
10
1
N 1 Z 0
Notes
N
i =1 (Zi Z )(Yi Y )
bIV
=
2
N
i =1 (Zi Z )(Xi X )
Proposition
bIV
2 is consistent provided that ZX is nonzero
11
Notes
bIV
2
=
=
N
i =1 (Zi Z )(Yi Y )
N
i =1 (Zi Z )(Xi X )
N
i =1 (Zi Z )([ 1 + 2 Xi + i ] [ 1 + 2 X + ])
N
i =1 (Zi Z )(Xi X )
N
i =1 ( 2 (Zi Z )(Xi X ) + (Zi Z )( i ))
N
i =1 (Zi Z )(Xi X )
N (Z Z )( i )
= 2 + Ni =1 i
i =1 (Zi Z )(Xi X )
Notes
= 2 +
plim
plim
= 2 + Z
ZX
N
1
N i =1 (Zi Z )( i
N
1
N i =1 (Zi Z )(Xi
)
X )
13
Notes
= 2 +
Corr (Z , X ) X
0
= 2 +
Cov (Z , X )
14
(4)
(5)
(6)
Notes
Comments
1
15
Notes
Comments - cont.
4. Even in the context of large sample results, it is not
unequivocally better to use iv rather than ols.
To see this compare (5) with the plim of the ols estimator
OLS,2 which we write as
(7)
16
Notes
17
Notes
(8)
= Z ( Z 0 Z ) 1 Z 0 X
b as instruments.
Using X
bIV
18
= ( X 0 P Z X ) 1 X 0 P Z y
= (X 0 Z ( Z 0 Z ) 1 Z 0 X ) 1 X 0 Z ( Z 0 Z ) 1 Z 0 y
(9)
Just Identified
Notes
Just-identified: M = k
The estimator with M = k (M the of cols. of Z ) is
often called the Instrumental Variable Estimator.
X 0 Z is a square matrix since M = k.
(10)
= (Z 0 X )1 (Z 0 Z )(X 0 Z )1 X 0 Z (Z 0 Z )1 Z 0 y
= (Z 0 X ) 1 Z 0 y .
19
Just Identified
Notes
20
Notes
Over-identified: M > k
The estimator is called the 2sls or Generalized
Instrumental Variable Estimator (give).
X 0 Z is not a square matrix since for M > k
(X 0 Z ( Z 0 Z ) 1 Z 0 X ) 1
cannot be decomposed.
The iv estimator is then given by
IV
= (X 0 Z ( Z 0 Z ) 1 Z 0 X ) 1 X 0 Z ( Z 0 Z ) 1 Z 0 y
21
Moment-Based Estimation
Notes
IV as Moment Estimators
We have motivated the iv estimator based on a transformed linear
regression model of the form Z 0 y = Z 0 X + Z 0 .
Alternative derivation: minimise a quadratic form of vector
moments: functions of parameters and data.
The gmm estimator is obtained by minimising a quadratic form in
the analogous sample moments: n1 [Z 0 y Z 0 X ]
Ignoring n1 then the gmm estimator is defined as
= arg min[(Z 0 y Z 0 X )0 C N (Z 0 y Z 0 X )]
22
(11)
Moment-Based Estimation
Notes
23
Notes
= (Z 0 X ) 1 (X 0 Z ) 1 X 0 Z Z 0 y
= (Z 0 X ) 1 Z 0 y
24
Notes
2SLS
If (0, 2 I ) the covariance matrix of the moment conditions is
Var(Z 0 (y X b)) = Var(Z 0 ) = 2 Z 0 Z .
An optimal weighting matrix is then
CN =
1
N
z i z i0
! 1
i =1
Notes
26
Proposition
Notes
bGMM = b2SLS = (X 0 Z (Z 0 Z )1 Z 0 X )1 X 0 Z (Z 0 Z )1 Z 0 y .
Proof.
QC ( ) = (y X b)0 P Z (y X b)
= (y X b)0 Z (Z Z0 Z )1 Z 0 (y X b)
= [Z 0 (y X b)](Z 0 Z )1 [Z 0 (y X b)]
= [Z 0 (y X b)]C N [Z 0 (y X b)]
= y 0 P Z y + b0 X 0 P Z X b 2 b0 X 0 P Z y
QC ( )
b
(12)
(13)
(14)
(15)
b0 X P Z X b 2 b0 X P Z y
b
b
= 2X 0 P Z X b 2X 0 P Z y = 0
= 2X 0 Z C N Z 0 X b 2X 0 Z 0 C N Z 0 y = 0.
(16)
(17)
27
Notes
(16) and (17) are derived, respectively, from (13) and (14)
Both (16) and (17) represent systems of M equations and k
unknowns, where X 0 Z is k M.
The solution to (16) is given by
GMM
28
= (X 0 P Z X ) 1 X 0 P Z y
1 0
= X 0 Z ( Z 0 Z ) 1 Z 0 X
X Z ( Z 0 Z ) 1 Z 0 y
= 2SLS
Notes
Proposition
GMM = IV and QC ( ) can be set to 0
Proof.
Substituting IV into (15) then
QC ( ) = y 0 P Z y + 0IV X P Z X IV 2 0IV X 0 P Z y
= y 0 Z ( Z 0 Z ) 1 Z 0 y
+ y 0 Z ( X 0 Z ) 1 X 0 Z ( Z 0 Z ) 1 Z 0 X ( Z 0 X ) 1 Z 0 y
20 Z ( X 0 Z ) 1 X 0 Z ( Z 0 Z ) 1 Z 0 y
= y 0 Z ( Z 0 Z ) 1 Z 0 y + y 0 Z ( Z 0 Z ) 1 Z 0 y
2y 0 Z (Z 0 Z )1 Z 0 y = 0
29
Notes
1
N
i =1
where V is given by
V
= plimN
1
N
z i0 b i b0i z i
i =1
Notes
31
Summary
Notes
32