Which of the following best characterizes the conditions for a good instrument?
A) Z is statistically significant in the first-stage and exerts a direct effect on Y.
B) Z is statistically significant in the first-stage and exerts no direct effect on Y.
C) Z is uncorrelated with both X and Y.
D) Z needs to be included in both stages in order for 2SLS to be appropriate.

Question

Quizplus · Accepted Answer

A good instrument should be statistically significant in the first-stage regression but have no direct effect on the outcome variable, Y. This ensures that the instrument is only affecting Y through its effect on the endogenous variable, X. Option A describes a situation where the instrument has a direct effect on Y, which would violate the assumption that the instrument only affects Y through X. Option C describes an uncorrelated variable, which would not be a useful instrument. Option D describes the requirement for the 2SLS method, but does not directly relate to the characteristics of a good instrument.

Which of the Following Best Characterizes the Conditions for a Good