Basic Econometrics 5th Edition by Damodar Gujarati,Dawn Porter

تمرين 5

Consider the model
Y t = + 1 X 1 t + 2 X 2 t + 3 Y t 1 + v t
Suppose Y t-1 and v t are correlated. To remove the correlation, suppose we use the following instrumental variable approach: First regress Y t on X 1 t and X 2 t and obtain the estimated from this regression. Then regress
Yt = + 1 X 1 t + 2 X 2 t + 3 t 1 + vt
where t 1 are estimated from the first-stage regression.
a. How does this procedure remove the correlation between Y t -1 and v t in the original model
b. What are the advantages of the recommended procedure over the Liviatan approach