Consider the model Suppose Yt1 and vt are correlated. To remove the correlation, suppose we use the
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Suppose Ytˆ’1 and vt are correlated. To remove the correlation, suppose we use the following instrumental variable approach: First regress Yt on X1t and X2t and obtain the estimated YÌ‚t from this regression. Then regress
where YÌ‚tˆ’1 are estimated from the first-stage regression.
a. How does this procedure remove the correlation between Ytˆ’1 and vt in the original model?
b. What are the advantages of the recommended procedure over the Liviatan approach?
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a The estimated Y values which are a lin...View the full answer
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