Factor-GMM estimation with large sets of possibly weak instruments

This paper analyses the use of factor analysis for instrumental variable estimation when the number of instruments tends to infinity. We consider cases where the unobserved factors are the optimal instruments but also cases where the factors are not necessarily the optimal instruments but can provide a summary of a large set of instruments. Further, the situations where many weak instruments exist and/or the factor structure is weak are also considered. Theoretical results, simulation experiments and empirical applications highlight the relevance of Factor-GMM estimation, which is also easily implemented. J.E.L. Classification: C32, C51, E52

• Type: Journal
• Year: 2010
• Where: CSDA
• Authors: George Kapetanios, Massimiliano Marcellino
• Keywords: CSDA 2010, Instrumental Variable Estimation, Instruments, Optimal Instruments