Heterogeneous endogeneity

Abstract

We define heterogeneous endogeneity as the case where a potentially endogenous regressor is endogenous for some sub-groups of the data but exogenous for other subgroups. We derive an estimator and test procedure based on the control function approach to deal with the phenomenon. We show that accounting for heterogeneous endogeneity can greatly increase the power of endogeneity tests and increase the precision of our estimator over traditional IV. While the gains get larger as the instrument gets weaker and as the relative size of the non-endogenous subgroup gets larger, we find efficiency gains even when the underlying instrument is very strong. We illustrate our approach with an example using data from Abaide et al. (Econometrica 70:91–117). © 2019, Springer-Verlag GmbH Germany, part of Springer Nature.