Identification

Standard tests
Identification and Overidentification

Testing Overidentifying Restrictions
IV/GMM Inference. Identification and

Overidentification
Walter Sosa-Escudero
Econ 507. Econometric Analysis. Spring 2009
March 8, 2009
IV/GMM Inference. Identification and Overidentification
Standard tests
Standard tests
Standard inference comes directly from the asymptotic normality result
d
n (g 0 ) N (0, AV(g ))
Then, it is easy to see that
Under H0 : k = k0
tk =
gk k0 p
nq
N (0, 1)
c gk )
AV(
c gk ) is any consistent estimator.

where AV(
Under H0 : R0 r = 0
p
c g )R0 ]1 (Rg r) 2 (q)

W = n(Rg r)0 [RAV(
with R, r and q defined as in our original large sample inference
problem.
Standard tests
Overidentification: Prelude
Suppose there are two instruments z1 and z2 , for a model

y = x0 + u where x is a single explanatory variable.
Suppose invalid instrument means that for no
E(zij ui ) = 0, j = 1, 2.
You use only one instrument, say z1 and get u
i = yi xi
where is the IV estimator using z1 as instrument.

What can you learn about instrument validity from the
correlation between u
i and z2i ?.
Standard tests

Recall that our moment conditions for the IV case are
E[zi (yi x0i 0 )] = 0,
and our problem was that the sample counterpart
n
1X
zi (yi x0i b) = 0
n
i=1
implies a system of p linear equations with K unknowns, which

cannot produce a solution when p > K.
If all the moment conditions are valid we could discard p K
moment conditions in any arbitrary way and produce a MM
estimator using the K moment conditions retained.
Standard tests
Another thing we can do is to combine the p moment conditions

linearly so as to produce K linearly independent moment
conditions, that is, use:
BE[z(yi x0i 0 )] = 0
where B is any K q matrix with (B) = K
In fact throwing away moment conditions implies a particular
choice of B! (which one?).
Note that the sample counterpart
n
1 X
B
zi (yi x0i b) = 0
n
i=1
produces a single solution (why?).

Standard tests
GMM as a particular case of MM?

GMM is choosing a particular B. Let ui (b) yi x0i b and
u(b) Y Xb. Recall that the GMM estimator minimizes:

1 0
1
0
u(b) Z Wn
Z u(b)
J(b) = n
n
n
so the FOCs are:
X 0Z
Z 0 u(b)
Wn
=0
n
n
which can be seen as the sample counterpart of:
E[xi zi0 ] W E[zi ui (0 )] = 0
| {z } | {z }
Kp
p1
which are K moment conditions!

Standard tests
E[xi zi0 ] W E[zi ui (0 )] = 0

| {z } | {z }
Kp
p1
Then
GMM is choosing a particular way of linearly combining the p
moment conditions so the system becomes exactly identified.
Standard tests
Identifying and Overidentifying Restrictions

It is very illuminating to explore how these linear combinations are
produced.
0
First note that W can be written as W = W 1/2 W 1/2 , where

W 1/2 is an invertible p p matrix.
It will be more convenient to re-express our original p moment
conditions as follows:
W 1/2 E[zi ui (0 )] = 0
Note that this does not alter at all the informational structure of
the problem (why?).
Standard tests
Now write the GMM version of the moment conditions as:

E[xi zi0 ] W E[zi ui (0 )] = 0
0
E[xi zi0 ] W 1/2 W 1/2 E[zi ui (0 )] = 0

F 0 W 1/2 E[zi ui (0 )] = 0
0
where F 0 E[xi zi ] W 1/2 . Note F 0 is K p with rank K.

Let h W 1/2 E[zi ui (0 )], so the moment conditions imply h = 0.
Standard tests
h = W 1/2 E[zi ui (0 )] is a p vector, and it can be decomposed

orthogonally as
h = Ph + Mh
where P and M are any pair of orthogonal projection matrices
that project h orthogonally onto some subspace and its orthogonal
complement.
Note that the moment condition implies P h = 0 and M h = 0.
Also, note that the decomposition holds for any pair of projection
matrices.
Standard tests
In particular for P = F (F 0 F )1 F 0 Pf , where

0
F 0 = E[xi zi0 ]W 1/2 .
Note F 0 is K p with rank K, hence Pf is the projection matrix

that projects vectors of dimension p onto the span of the K
column vectors in F , hence Pf has rank K and
Mf = I F (F 0 F )1 F 0 has rank p K
(Remember the dimension theorem...).
Standard tests
Then
F (F 0 F )1 F 0 h = 0,
forms a system of K linearly independent equations with K
unkowns.
Now note since F (F 0 F )1 F 0 has rank K, F (F 0 F )1 F 0 h = 0
whenever
F 0h = 0
which are the MM conditions derived from the GMM procedure.
This leds us to a very important result.
Standard tests
What GMM is doing in when p > K is decomposing the

moment conditions, h, in two orthogonal parts. One that is
used to exactly identify the relevant parameters (Pf h = 0)
and another part which is left unused (Mf h = 0).
The moment conditions Pf h = 0 are called the identifying
conditions and the conditions Mf h = 0 are called the
overidentifying conditions.
In a certain sense, we can see GMM as using a particular set
of K moment conditions and discarding the remaining p K.
Standard tests
Another interesting intuition is the following.

Wn1/2 n1 Pn zi ui (g ). Then the minimized GMM
Let h
i=1
objective function can be expressed as:
0h
J(g ) = n h
1/20
Let Fn n1 X 0 Z Wn , Pf n = Fn (Fn0 Fn )1 Fn0 and

Mf n = I p P f n .
= (Pf n + Mf n )h.
Replacing
By orthogonal decomposition, h
above and using the properties of these matrices:
h
i
0 (Pf n + Mf n )(Pf n + Mf n )h
J(g ) = n h
h
i
0
= n h (Pf n + Mf n )h
h
i
0 Pf n h
+h
0 Mf n h
= n h
Standard tests
i
h
+h
0 Mf n h
0 Pf n h
J(g ) = n h
= 0, which leds to a
The FOC of the GMM problem sets Pf n h
very useful intuituion about how GMM works and its usefulness for
testing:
The GMM estimator satisfies strictly the identifying
restrictions and tries to make the overidentifying restrictions
as small as possible.
0 Mf n h
measures how far
The minimized value of J(g ) = n h
is the sample from satisfying the overidentifying restrictions.
Standard tests
Testing overidentifying restrictions

Intuituion:
The fact that J(g ) measures how far is the sample from
satisfying the overidentifying restrictions can be exploited to
design a formal specification test.
If all the assumptions of the overidentified GMM model hold,
then asymptotically the overidentifying conditions should be
satisfied: the identifying conditions succeed in producing a
consistent estimator and hence force all moment conditions to
hold.
If the J(g ) is too large then some of the conditions that
guarantee consistency and asymptotic normality are likely to
be false (more on this later).
Standard tests
The J test: the test statistic for the overidentifying restrictions

test is:
u(n )0 Z 1 Z 0 u(i )
Sn
n
n
and under H0 : E[zi ui (0 )] = 0 it converges in distribution to
2 (p K).
J = Jn (g ) = n
First note that the test uses the optimal GMM estimator, that
is, Wn = Sn1 .
Intuition: the J test checks if the GMM is small. According
to our previous result, this means checking if the
overidentifying restrictions are small.
Under the null that the model is correctly specified (all GMM
assumptions hold), GMM is consistent and hence the
overidentifying restrictions should be close to zero.
Standard tests
What happens under the alternative hypothesis?

Suppose the rank condition holds. The sample version of the
p
identifying conditions must be satisfied, so g + .
Asymptotic normality of the moment conditions also holds,
but centered at some other place that is not zero.
Rewrite the statistic as:
J =n
u(n )0 Z 1 Z 0 u(i )
Sn
n
n
Then when H0 does not hold, n and the remaining part

converges to something not centered at zero, then J .
It is a global test for misspecification. It may mean that some
moment conditions are invalid and/or that the model is
misspecified.
Standard tests
Proof: By our previous result

i
h
0 Mf n h
Jn (g ) = n h
Wn1/2 Z u(g ) , so
with h
n
)0
(
)
(
0
0
1/2 Z u(g )
1/2 Z u(g )
Mf n W n
Jn = Wn
n
n
0
From the asymptotic normality proof of GMM we got

Z 0 u(g ) d
N (0, S).
n
1/2
If Wn = Sn1 and Wn
Wn1/2
= S1/2
Z 0 u(g )
Z 0 u(g ) d
= S1/2
N (O, Ip )
n
n
Standard tests
Hence, the J test is an quadratic form of a p vector of independent

normal variables, normed by an idempotent matrix with rank
p K, then the result follows.
Recall that if y N (0, Ip ) and A is an idempotent matrix with rank q, then y 0 Ay 2 (q) (Hayashi (2000,
p. 37)).

Identification

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Standard tests

Identification and Overidentification

IV/GMM Inference. Identification and

IV/GMM Inference. Identification and Overidentification

c gk ) is any consistent estimator.

c g )R0 ]1 (Rg r) 2 (q)

IV/GMM Inference. Identification and Overidentification

Suppose there are two instruments z1 and z2 , for a model

where is the IV estimator using z1 as instrument.

IV/GMM Inference. Identification and Overidentification

Identification and Overidentification

implies a system of p linear equations with K unknowns, which

IV/GMM Inference. Identification and Overidentification

Another thing we can do is to combine the p moment conditions

produces a single solution (why?).

IV/GMM Inference. Identification and Overidentification

GMM as a particular case of MM?

which are K moment conditions!

IV/GMM Inference. Identification and Overidentification

E[xi zi0 ] W E[zi ui (0 )] = 0

IV/GMM Inference. Identification and Overidentification

Identifying and Overidentifying Restrictions

First note that W can be written as W = W 1/2 W 1/2 , where

IV/GMM Inference. Identification and Overidentification

Now write the GMM version of the moment conditions as:

E[xi zi0 ] W 1/2 W 1/2 E[zi ui (0 )] = 0

where F 0 E[xi zi ] W 1/2 . Note F 0 is K p with rank K.

IV/GMM Inference. Identification and Overidentification

h = W 1/2 E[zi ui (0 )] is a p vector, and it can be decomposed

IV/GMM Inference. Identification and Overidentification

In particular for P = F (F 0 F )1 F 0 Pf , where

Note F 0 is K p with rank K, hence Pf is the projection matrix

IV/GMM Inference. Identification and Overidentification

IV/GMM Inference. Identification and Overidentification

What GMM is doing in when p > K is decomposing the

IV/GMM Inference. Identification and Overidentification

Another interesting intuition is the following.

Let Fn n1 X 0 Z Wn , Pf n = Fn (Fn0 Fn )1 Fn0 and

IV/GMM Inference. Identification and Overidentification

IV/GMM Inference. Identification and Overidentification

Testing overidentifying restrictions

IV/GMM Inference. Identification and Overidentification

The J test: the test statistic for the overidentifying restrictions

IV/GMM Inference. Identification and Overidentification

What happens under the alternative hypothesis?

Then when H0 does not hold, n and the remaining part

IV/GMM Inference. Identification and Overidentification

Proof: By our previous result

From the asymptotic normality proof of GMM we got

IV/GMM Inference. Identification and Overidentification

Hence, the J test is an quadratic form of a p vector of independent

IV/GMM Inference. Identification and Overidentification

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