Instrument approval by the Sargan test and its consequences for coefficient estimation

Empirical econometric findings are often vindicated by supplementing them with the p-values of Sargan–Hansen tests for overidentifying restrictions, provided these exceed a chosen small nominal significance level. It is illustrated here that the probability that such tests reject instrument validity...

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Bibliographic Details
Published in:Economics letters 2021-08, Vol.205, p.109935, Article 109935
Main Authors: Kiviet, Jan F., Kripfganz, Sebastian
Format: Article
Language:English
Subjects:
Asymptotic methods
Econometrics
Endogeneity testing
Estimating techniques
Instrument validity
Instrument weakness
Probability
Simulation
Size control
Studies
Test power
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Summary:Empirical econometric findings are often vindicated by supplementing them with the p-values of Sargan–Hansen tests for overidentifying restrictions, provided these exceed a chosen small nominal significance level. It is illustrated here that the probability that such tests reject instrument validity may often barely exceed small levels, even when instruments are seriously invalid, whereas even minor invalidity of instruments can severely undermine inference on regression coefficients by instrumental variable estimators. These uncomfortable patterns may be aggravated when particular valid or invalid instruments are relatively weak or strong. •Sargan–Hansen tests for validity of all external instruments are inconsistent.•They lack power when instruments have certain unverifiable characteristics.•Crucial are ratios of degrees of instrument invalidity over instrument strength.•Therefore, instrumental variables based inference will always be ambiguous.•Inference based on endogeneity intervals avoids using dubious instruments.
ISSN:0165-1765
1873-7374
DOI:10.1016/j.econlet.2021.109935