5 - Testing for Weak Instruments in Linear IV Regression  pp. 80-108

Testing for Weak Instruments in Linear IV Regression

By James H. Stock and Motohiro Yogo

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ABSTRACT

Weak instruments can produce biased IV estimators and hypothesis tests with large size distortions. But what, precisely, are weak instruments, and how does one detect them in practice? This paper proposes quantitative definitions of weak instruments based on the maximum IV estimator bias, or the maximum Wald test size distortion, when there are multiple endogenous regressors. We tabulate critical values that enable using the first-stage F-statistic (or, when there are multiple endogenous regressors, the Cragg–Donald [1993] statistic) to test whether the given instruments are weak.

INTRODUCTION

Standard treatments of instrumental variables (IV) regression stress that for instruments to be valid they must be exogenous. It is also important, however, that the second condition for a valid instrument, instrument relevance, holds, for if the instruments are only marginally relevant, or “weak,” then first-order asymptotics can be a poor guide to the actual sampling distributions of conventional IV regression statistics.

At a formal level, the strength of the instruments matters because the natural measure of this strength – the so-called concentration parameter – plays a role formally akin to the sample size in IV regression statistics. Rothenberg (1984) makes this point in his survey of approximations to the distributions of estimators and test statistics.