| Abstract: | In this paper we propose a new estimator for a model with one endogenous regressor and many instrumental variables. Our motivation comes from the recent literature on the poor properties of standard instrumental variables estimators when the instrumental variables are weakly correlated with the endogenous regressor. Our proposed estimator puts a random coefficients structure on the relation between the endogenous regressor and the instruments. The variance of the random coefficients is modelled as an unknown parameter. In addition to proposing a new estimator, our analysis yields new insights into the properties of the standard two‐stage least squares (TSLS) and limited‐information maximum likelihood (LIML) estimators in the case with many weak instruments. We show that in some interesting cases, TSLS and LIML can be approximated by maximizing the random effects likelihood subject to particular constraints. We show that statistics based on comparisons of the unconstrained estimates of these parameters to the implicit TSLS and LIML restrictions can be used to identify settings when standard large sample approximations to the distributions of TSLS and LIML are likely to perform poorly. We also show that with many weak instruments, LIML confidence intervals are likely to have under‐coverage, even though its finite sample distribution is approximately centered at the true value of the parameter. In an application with real data and simulations around this data set, the proposed estimator performs markedly better than TSLS and LIML, both in terms of coverage rate and in terms of risk. |
