UNIVARIATE REGRESSION:
SCALING VARIABLES:
If you scale the dependent variable, the original confidence intervals, interpretations, etc remain the same.
Only the beta & the alpha change.& the SEs increase. Suppose y variable was in 1000s and you want to
change it in raw dollars, the beta and alpha both will get multiplied with 1000.
Scaling the independent variable will lead to a change in the beta & SEs ONLY. Suppose your x variable was
ROE in % and you want to change it to decimals. If you multiply ROE with k, then divide the beta with k too.
The alpha would remain the same..
If you want to scale both, the y and the x variable, then multiply the alpha and beta with the dependent
variable scaling multiple and divide the beta for the independent scaling variable. Basically, combine the
above both. Interpretations never change.
SHIFTING X & Y VARIABLES BY ADDING SOMETHIING TO X AND Y: Idea is that you can add or subtract to x or
y variables and it would not change anything. The intercept would change but the conclusion will remain the
same. No change in the causal inference too.
LOG-ING Y Variable:
ln(𝑤𝑎𝑔𝑒) = 𝛼 + 𝛽 𝑒𝑑𝑢𝑐𝑎𝑡𝑖𝑜𝑛 + 𝑢 Δ ln( 𝑤𝑎𝑔𝑒) = 𝛽Δ𝑒𝑑𝑢𝑐𝑎𝑡𝑖𝑜𝑛
100 × Δ ln( 𝑤𝑎𝑔𝑒) = (100𝛽)Δ𝑒𝑑𝑢𝑐𝑎𝑡𝑖𝑜𝑛
𝑤𝑎𝑔𝑒 = (100𝛽)Δ𝑒𝑑𝑢𝑐𝑎𝑡𝑖𝑜𝑛 𝑤𝑎𝑔𝑒
100 × Δ 0 PANEL DATA AND FE REGRESSION:
%Δ𝑤𝑎𝑔𝑒 ≈ (100𝛽)Δ𝑒𝑑𝑢𝑐𝑎𝑡𝑖𝑜𝑛
The proportionate change in y for a given change in x is assumed constant. The change in y is not assumed to
be constant... it gets larger as x increases. The right interpretation is that 1 unit change in x leads to
(beta*100) y change in the y variable.
ln(wage) = 0.584 + 0.083education--- What does an additional year of education get you? Answer: = Avg
increase of 8.3% in wages. The problem with this specification is that it ignores non-linearities. That is, there
are bigger effects from graduating from high school, and college with a diploma.
LOG-ING X Variable:
Suppose you estimated the CEO salary model using logs got the following, where salary is expressed in $000s:
salary = 4.822 + 1,812.5ln(sales) … What is the interpretation of 1,812.5? Answer = For each 1% increase in
sales, salary increases by $18,125. This is because beta/100 is the change in y for 1% change in x.
LOG-ING X&Y Variable: ln(salary) = 4.822 + 0.257ln(sales)… What is the interpretation of 0.257? Answer = For
each 1% increase in sales, salary increases by 0.257%
RESCALING LOGS DO NOT MATTER: What happens if you try and rescale the log dependent or log
independent (log y)? Multiplying it is just like adding logs. Therefore, no changes to the beta. Just the
intercept changes.
WHEN TRUE % change in y becomes larger, 100 Δ ln (y) = % change in y does not hold true. The true %
change is: [(𝑦′−𝑦)/𝑦 %=100 exp 𝛽(𝑥′−𝑥) −1]. So, if 𝛽 is -1.386, true change in y is not 100 x -1.386 = -138.6%,
but it is: 100× 𝑒−1.386 −1%=100× .25 −1 =−75%
USE OF LOGS: Logs of y or x can mitigate influence of outliers. Helpful to take logs for variables with Positive
currency amount assets, liabs, etc; Large integral values (e.g. population) BUT Don’t take logs for variables
measured in years or as proportions. Proportions ROA/ROI/Leverage/any ratio.
What is the % change in the unemployment if it goes from 10% to 9%--> A 10% drop OR a 1% point drop.
MULTIVARIATE REGRESSION:
Assumptions: No perfect collinearity among covariates AND E(u|x1,x2,…) = 0. This implies that there is no
perfect correlation between x and u, which means we have the perfect model and a true causal relationship.
Interpretations: Generally, we just look at changes in one x (say x1) holding all the other constant. In this
case, x1 becomes variable of interest. Intercept has meaning sometimes but sometimes it does not.
Another way of getting the multivariate regression (Partialing out way): #1 – Regress y on x2; save residuals
(call them 𝑦z ) #2  Regress x1 on x2; save residuals (call them 𝑥z) #3 – Regress 𝑦z onto 𝑥z and NOW the
estimated coefficient will be the same as if you’d just run the original multivariate regression! A multi-variate
regression is basically finding the effect of each independent variable after partial-ing out the effect of other
variables.
This partial-ing out effect holds more generally when x1 is a set of other independent variables and x2 is
another set. In this case, you would first regress y on all the variables in x2. (Residuals yz) Then regress each
variable in x1 (residuals xz) on all variables in x2 (residuals xz). Regress yz on corresponding residuals of xz
one-by one.
R^2: First started by discussing about the SST, SSE and SSR. SST is total variation in y. SSE is total variation in
predicted y (which is the mean of predicted y = mean of y). SST is total variation in residuals (mean of resi=0).
Total variation can be broken into (explained) & SSR (unexplained). R^2 is the share of explained= SSE/SST = 1-
(SSR/SST). It is also equal to the square of correlation between y and predicted y. BUT it never goes down as
variables goes up. AdjR^2= 1 – (1-R^2)((N-1/(N-1-K)). Interpretation of R^2: If R2 is 0.014, It means the model
is only being able to explain 1.4% change in y with the regressors included. Low R^2 is never wrong. Even with
low R^2, we can get a consistent resulting beta. Difference in beta and R^2: Beta only says the effect of x on
y. But a question like am I being able to explain all variation in y? has to be answered with R^2.
Including irrelevant regressor: Incl irrelevant regressors will still give us a consistent beta for all but the
irrelevant beta would be 0. The problem would be the standard errors which might increase putting pressure
on significance. Therefore, it is useful to know what increases the variance of beta.
Rj is regression on xj on other variables.
Things to note: 1) more variation in x lowers SE. Another way to understand is that if everyone has the same
height, there is no way to predict weight. 2) higher variance leads to higher SE reducing precision of model.
High variance means large residuals which would mean that y is not predicted well. To improve estimate of a
particular beta, add x variables hat predict y better. 3) if an x variable that is highly correlated with other x
variable is added, Rj^2 would increase and the SE would also increase. So do not add variables that are
irrelevant.
QUESTION: Should we include x variables that explain y and are highly correlated with our x of interest? Ans:
Highly collinear variables can inflate SE but do not result in bias or inconsistencies. With large sample, we
could get more variation in x and more precise beta. If there are 3 variables and x2 and x3 are highly
correlated, Var of B2 and B3 may be high but correlation between them has no direct effect on Var B1 . If x1
is uncorrelated with x2 and x3, the R1^2 = 0 and variance of B1 is unaffected.
DUMMY VARIABLES:
Ex of categorical dummy: male, female, employed/unemployed, ex of cross-sectional comparison: Size of firm
above/below or pay of CEO above/below median.
Interpretation of single dummy models: 𝑤𝑎𝑔𝑒=𝛽0 +𝛿 𝑓𝑒𝑚𝑎𝑙𝑒+𝛽1 𝑒𝑑𝑢𝑐. Gama 0 measures the difference in
wage between male and female with the same level of education. Female is the dummy variables. Wage for
male= B0 + B1 educ. Wage for female= (B0 + Gama 0 + B1 Educ). Intercept will be B0 & (B0 + Game 0). Single
dummy just shifts intercept- it does not effect the slope.
Interpretations of single dummy. 1) Wage = -1.57 – 1.8female + 0.57educ + 0.03exp + 0.14tenure  Female is
the dummy and 1.8 coeff means that on an avg, females earn 1.8$/hour lesser than men with other things
remaining same. 2) 𝒍𝒏(𝒑𝒓𝒊𝒄𝒆) = −𝟏. 𝟑𝟓 + 𝟎. 𝟏𝟕 𝒍𝒏( 𝒍𝒐𝒕𝒔𝒊𝒛𝒆) + 𝟎. 𝟕𝟏 𝒍𝒏( 𝒔𝒒𝒓𝒇𝒕) + 𝟎.𝟎𝟑𝒃𝒅𝒓𝒎𝒔 + 𝟎.
𝟎𝟓𝟒𝒄𝒐𝒍𝒐𝒏𝒊𝒂𝒍  means that colonial homes cost 5.4% more than otherwise similar homes on an avg.
Multiple indicator variables: Suppose you know how much lower wages are for married and single females.
Four possible outcomes: S&M, S&F, M&M,M&F. But create only 3 categories idea being that if you put 3
categories, you automatically know the 4th one. This would make the the data very collinear. The selection of
which 3 categories does not matter. It just effects the interpretation of the equation. Ex: If we exclude S&M,
we are estimating partial change in wage relative to that of S&M. Suppose, this is the eqn: ln( 𝑤𝑎𝑔𝑒) = 0.3 +
0.21 𝑚𝑎𝑟𝑟𝑖𝑒𝑑 𝑀𝑎𝑙𝑒 − .20𝑚𝑎𝑟𝑟𝑖𝑒𝑑𝐹𝑒𝑚𝑎𝑙𝑒 −0.11𝑠𝑖𝑛𝑔𝑙𝑒𝐹𝑒𝑚𝑎𝑙𝑒 + 0.08𝑒𝑑𝑢𝑐𝑎𝑡𝑖𝑜n. Single males are omitted.
Therefore, interpretations would be like single males earn 21% more than married male or 30% lesser than
married woman, all else equal.
Interactions with variables: Now suppose this becomes:
𝒍𝒏(𝒘𝒂𝒈𝒆)=𝟎.𝟑−𝟎.𝟏𝟏𝒇𝒆𝒎𝒂𝒍𝒆+𝟎.𝟐𝟏𝒎𝒂𝒓𝒓𝒊𝒆𝒅−𝟎.𝟑𝟎 𝒇𝒆𝒎𝒂𝒍𝒆×𝒎𝒂𝒓𝒓𝒊𝒆𝒅 +𝟎.𝟎𝟖𝒆𝒅𝒖𝒄𝒂𝒕𝒊𝒐𝒏  Before,
married females had wages that were 0.20 lower than single males. How about now? Note: Omited catogory
is single male. So lets start with that: • Start with single male: 0.30. Make single male to female (i.e., single
female): 0.30 -0.11x1 = 0.19. Make single male to married (i.e., married male): 0.30 + 0.21 x 1 = 0.51. Make
single male to married female (married female): 0.30 - 0.11 + 0.21 – 0.30 = 0.10 • Difference: 0.10 – 0.30 = -
0.20. Same! Note that the things that we take out is just what they make. So 0.19 means that it is what single
females make. That is why, at the end, we subtract 0.1-0.3 to know how much married woman less than
single males.
Note: From the vision slide, we cannot conclude that women earn more than men. We first need to calc the
crossover rate and see if it makes sense. Crossover point is when eqn men=eqn woman. => Educ=
Gama0/Gama1. It might occur outside the data (at education levels that do not exist).
ORDINAL INDEPENDENT VARIABLES: The difference between this and indicator variable is that it has more
than 2 variables on the ‘x side’. Suppose we want to regress int rate on rating. Put AAA=1,AA=2, etc and
estimate: 𝐼𝑅 =𝛽0 +𝛽1 × 𝐶𝑅 +𝑢. The problem with this is that we assume constant linear relation but in reality
that is not the case. A better way is to convert ordinal to indicator variables.
CMI AND VIOLATIONS OF CMI:
If x causes y, it does not mean that it will have a high correlation. Only if there are 2 variables (x,y), causation
will imply correlation. Otherwise, the third variable can be too strong and correlation might be low.
Also note, in a true model, X is only one of the many possible causes of Y so it is not true that only X causes Y.
Also, if there is causation, it is not true that it will always lead to Y, rather, it will be there occurrence of Y
becomes more probable. In a true model, there are many variables and y is affected by all variables+error.
Assumptions for causal interpretations: 1st: E(u)=0 --) Not a storng adj  always adj and make it 0. 2nd: E(u|
x1,x2…xk) = E(u) for all values of xk. This is the CMI assumption. It basically means that the avg value of u
does not depend on x. OR knowing the value of x does not tell you anything about the value of y, except
through the relation B1*X OR the estimation error is uncorrelated with all the x. Suppose: wage=
B0+Edu*B1+u and u over here is ability OR knowing the value of x does not help us ascertain the value of u.
CMI says that any value of x will give us 0. So a person with 1 yr of education should have same ability as
someone with 5 years of education. The problem with this is that we generally do know what is u. By default,
CMi is always violated.
OVB: Most common concern is that estimation error (say z) contains another variable that affects y AND is
correlated with x. NOTE: OBV is only problematic if correlated with x. True B1= B1 + [Cov(x,z)/var(x)]*B2.
Cov/Var is one way of getting B. B1 takes y on x and B2 takes z on y. the entire second half is the bias.
We see bias is equal to 0 either when y is uncorrelated with z or B2=0 or cov(x,z) is 0. Take the education
and efficiency example. If we exclude efficiency, it is likely that the cov between education and efficiency is
positive. Therefore, the bias is positive. Estimated B1 is bigger than the estimate. BUT WE CAN ONLY PREDICT
BIAS WHEN THERE IS 1 VARIABLE THAT IS OMITED. The moment that we say that more than 1 variable is
omitted, it is imp to know the sign of the bias.
ELIMINATING OVB: If observable, just add as control. If not, make a proxy. Ex: IQ as proxy for efficiency in the
above equation. True model: 𝑦=𝛽 +𝛽1𝑥1 +𝛽2𝑥2 +𝛽3𝑥∗3+𝑢 Estimated Model: 𝑦=𝛽0 +𝛽1 𝑥1 +𝛽2 𝑥2 +𝛽3𝑥3
+𝑢, where 𝑥∗3 =𝛿0 +𝛿 𝑥3 +𝑣. Assumptions: 1) E(u|x1,x2,x3*)=0. This means model is correct as E(u|
x2=0) and 2) E(v|x1,x2,x3*)= 0. i.e. x3 is a good proxy for x3*. So that after controlling for x3, x3* does
not depend on x1 or x2.
PRACTICAL ASSUMP FOR GOOD PROXY: Suppose the same eqn. We need to assume that E(eff|IQ)=E(e|
IQ,Edu). It means that avg efficiency does not change with education, after controlling for IQ. OR Only the
proxy explains efficiency and education does not. When choosing proxy, ensure that 1) unobserved var
is related to y, 2) proxy is correlated with the unobserved variable 3) proxy is uncorrelated with other x
variables in the model.
ME: ME basically represents the imprecise measurement of variable of interests. Proxy and ME are different
things. Proxy is used for things entirely unobservable and ME’s variables are well-defined. ME in ‘y’ variable
only effects SEs and not betas. When there is a ME in y variable, the error term becomes u+e. We assume
that E(e)=0—does not matter as this violation only affects intercept and that, corr(u,e)=0. As long as the
measurement error in y is uncorrelated with the x’s, B is unbiased. Because V(u+e)>V(u), SEs are higher. Is
assuming e and x are uncorrelated plausible?--> depends on the variables. Suppose, we are estimating value
of firm value controlling for profitability. If we use book value of debt, there will be a ME as MV of debt should
be used. But in this case, ME will be correlated with x as debt is correlated with profitability. Therefore, the
assumption is violated and B will be inconsistent. When ME is in the x variable- e=x-x*. 2 situations, e is
uncorrelated with observed measure x (no bias & SE becomes higher) OR e is uncorrelated with unobserved
measure x* (bias since e uncorrelated with x* guarantees e is correlated with x). With measurement error,
the estimated beta is always small (attenuation bias). This is because you are underestimating the true
effect. In reality, some attenuation is likely cus e is correlated with x and x*.
Samultaneity Bias: if y affects any x (even controls), all betas will be biased.
Helps with the unobserved variables that does not vary within the groups of observations. Essentially captures
all the unobserved variables within a group that’s why called unobserved heterogeneity.
Another way to to do FE estimation is by adding an indicator (dummy) variable. Since the delta and fi in the
above slides have no meaning, we can rescale them to make fi = 1. Now to estimate this, we can treat each fi
as a parameter to 1. The equation is the same- just without delta.  this means create a dummy variable for
group i and add to the regression. The transformation is called least squares dummy variable. The results are
causal. Because dummy variables together are collinear, one of them will be dropped so do not try and
interpret the intercept. It is just the avg y when all the x = 0 for the group (any one of the firm in prev ex)
corresponding to the dummy. If have 500 companies, put 499 and put that company’s row to 1 and others 0.
Additonal things to note: i) Company fixed effect means that suppose apple’s data is across 5 years that there
are 15 obs. All the obs will become one group. ii) Year FE means all observations for that year vecomes a
group. Like all observations in 1995 becomes a group. Every year would now have its own intercept. iii) It is
imp to know at what level is your panel data defined. iv) Any column that can divide your observations into
groups, you can use FE. Similarly, industry and CEO FE can also be put. IN THE CONCLUSION, coefficient is
identified using only changes in cross-sections.
CONS OF FE: CANNOT IDENTIFY VARIABLES THAT DO NOT VARY WITHIN THE GROUP. All the group level
charecteristics will be removed/swept out in within transformation.
ln(𝑡𝑜𝑡𝑎𝑙𝑝𝑎𝑦) =𝛼+𝛽 ln(𝑓𝑖𝑟𝑚𝑠𝑖𝑧𝑒)ijt +𝛽 𝑅𝑂𝐸 +𝛽 𝑓𝑒𝑚𝑎𝑙𝑒i +𝛿t (->time FE)+𝑓i (->CEO FE)+𝜆j (->Firm FE) +𝑢
In the above, female B cannot be estimated as CEO fixed effect takes care of that. There is no variation in
the gender of the CEO  female dummy would be collinear with the CEO FE.
INSTRUMENTAL VARIABLES:
Why is IV imp? If one of the x is correlated with the error term, it will be a breach of CMI. The only way to get
correct result would be if x should not be there or x is not correlated with other x variables very unlikely.
One way to get past it is FE regression but what if the x is not fixed within groups? Then we use IV. Suppose in
a regression eqn, cov(xk,u)≠0  then think that xk has a good and a bad variation. Good variation is
uncorrelated with u and bad variation is correlated. An IV is a variable that effects xk but does not affect y
(i.e. it only explains the good variation in xk). In this case, we can use IV to replace xk with just good
variation. IV must satisfy 2 conditions:1) Relevance condition: IV (z) must be explain xk after controlling for
all other x. To find this regress xk on z 2) Exclusion Condition: ‘z’ must be uncorrelated with the error term in
the original model (original model is the one with xk). It basically means that z has no explanatory power with
respect to y after conditioning on the other X. It can only explain Y through xk. This is based on economic
logic. 2 stages to put in IV: i) regress xk on other x & z. And then, put the predicted value of xk from stage
one in place of the other xk.
IV is like a scaled version of a proxy variable. In IV, we replace the problematic x variable with the value
predicted by instrument.
A WEAK IV is one that does not explain much of the problematic xk & leaves SEs in the first stage regression.
F-stat in the first stage will be low. F-stat of 10 or larger is desirable.
WHEN MORE THAN 1 PROBLEMATIC X Suppose xk-1 and xk are problematic and the IVs for both are z and
z1. Regress xk-1 on all other x’s except xk and both instruments z and z1. Then do the same with xk on all
other x’s other than xk-1. Get the predicted value and do the next stage regression.
NATURAL EXPERIMENTS & DID:
NATURAL EXPERIMENTS: If COV(x,u)≠0, then CMI violated. We can also think of it as x not being random (i.e.
the dist of x is not random). Eg. Firms with high x might have a higher y because high x is more likely for firms
with some omitted variable contained in u.
THE PROBLEM HERE IS ENDOGENEITY. Companies decide both x and y and therefore bias is present which is
OBV or any other. Therefore cannot lead to causal inference. Therefore, we need a natural experiment-
which is an event that causes random assignment of the variable of interest- x. Examples: i) Suppose texas
govt stopped use of stock options. For is to be exogenous, you have to prove that the fact that they stopped
had got nothing to do with the firms. Now we can compare companies in and outside Texas. ii) if SEC haulting
trade has anything to do with the risk preference of the investor, then it is not random. But if it is something
else that leads to it, then it is random. THE FACT REMAINS ONE- THE “EVENT” SHOULD NOT BE IN CONTROL
OF THE OBSERVATION UNIT OR IN OTHER WORDS, SHOULD BE EXOGENOUS. It DOES NOT mean that x and
y are not related, it just means that the ‘event’ is causing x to change.
NEs can be used to construct an IV or used to construct a threshold for RDD but, generally it is used when we
talk about difference in differences. Basically- this method compares y for a treated group to the outcome
variable y of the untreated group when treatment is randomly assigned by the NE.
d = treatment/assignment indicator (a switch)
d=0  untreated ; d=1 treated .. therefore the switching equation= y= y0 + d (y1 – y0) = dy1 + (1-d)y0. If
d=1, y=y1 and if d=0, y=y0.
ATT (Avg treatment effect if treated)- E[y1 – y0|d=1)] .. it is basically the effect of treatment on those who
receive treatment… Unobservable
ATU (Avg treatment effect if untreated)- E[y1-y0|d=0].. it is the effect if treatment on those who are in control
group.
Example solution: the fact that some companies are rated and some are not is in itself not random. Firm with
rating likely to be more profitable. Therefore selection bias will be positive. Even adding controls might not
help if firms differ in unobservable ways like investment opportunities.
DID test general: A quasi-experimental research design to estimate effects using archival data.
Anecdotal evidence is one using your story to back up your claim. This is it causation.
This is also randomized if you go to each person’s house, toss and give treatment based on coin toss. Ex: give
dirty water if tails and clean water if heads.
Parrallel trends: Absent treatment, the change in y for treated would not have been different than the change
in y for the untreated observations.
Violation of parallel trends: There is no effect, but B3 from the slide above > 0 because parallel trends was
violated. I.E. the outcome in treated group would have increased relative to the control, absent treatment.
Why is DID preferred? The required argument to suggest DID estimate is not causal is . The change in y for
treated observations after treatment would have been different than change in y for untreated observations
for reasons a, b, and c, and these reasons are correlated with both whether a group is treated and when the
treatment occurs. This is (usually) a much convoluted and harder story to justify
REGRESSION DISCONTINUITY:
The basic idea of RDD is that options are treated based on a known cutoff rule. Eg: for the observable, x, an
observation is treated if x ≥ x’. This cutoff creates discontinuity. We are interested in evaluating the effect on
outcome variable y of the treatment effect (of being above the cutoff). In RDD, it is necessary to compare the
outcome variable y just above or below the cut-off.
Example of setting: 1) Suppose we want to test the effect of vaccine on COVID & there is a scheme that says
only people above 50 are eligible for the vaccination. What we have to do here is that know that people just
below and above would have the same characteristics buttill people below would not be getting the
vaccination. So, id you test the samples for cutoff, you should get to know the effect of COVID. If 50 was
chosen as a cutoff by policy-setters knowing that that is the age when people get COVID more, then no
causality. Therefore, the rule-setting should be independent of x.
Example 2) Borrower FICO score > 620 makes securitization of loan more likely. This is an exogenous change
as companies just above or below the cutoff are same but it is only because of the cutoff that securitization is
easy. AUTHORS WILL ARGUE THAT FICO score 620 is just an industry practice and was not chosen in the sense
that people who fall just below the 620 are more likely to default than others AND that people cannot choose
their own scores otherwise people would force to be above 620. The first reason just argues that cutoff was
found independent of the x variables.
HOW IS THE TREATMENT RANDOM WHEN IT IS BASED ON A CUTOFF?  We assume that the observation
unit cannot perfectly manipulate the value of x. Therefore, whether or not the unit falls above or below the
cutoff is totally random.
2 types of RDD: Sharp RDD: Assignment of treatment depends only on x. If x>x’, then treated. OR Fuzzy RDD:
x>x’ only increases the probability of treatment but other factors still influence whether the unit is actually
treated or no. For Fuzzy, the avg change in y understates the causal effect, because the comparison assumes
all observations were treated. Therefore, rescale the avg change in y around the threshold based on the
change in probability of the treatment.
The variable which decides the assignment of x is called the forcing or the running variable. X’ is the
threshold. Y0 is outcome absent treatment & y1 is outcome with treatment.
ASSUMPTIONS 1:
FUZZY RDD: Treatment probability increases after cutoff. Some are untreated after cutoff and some are
treated below cutoff. Therefore, we conclude like: a borrower with fico score >620 makes securitization more
likely but whether or not he gets it securitized depends on documents and all too.
ASSUMTIPN 2: Local Continuity: We do not expect any jump around the threshold x’ , in absence of the
treatment. Y variable is smooth a function around threshold if no treatment. The parallel trend assumption in
DID that assumes that the units would have been same without treatment is equivalent to continuity assump.
Will the below regression reveal causal effect of treatment, d, on y? Regression:𝒚𝒊 =𝜷𝟎+𝜷𝟏𝒅𝒊+𝒖𝒊 (d takes
value 1 if above cutoff. Unlikely! d is correlated with x, and if x affects y, then there will be omitted variable!
E.g., Borrowers FICO score, used in Keys, et al (2010), affects likelihood of default. Therefore, above
regression can NOT be used to determine effect of securitization on default risk
How can we modify previous regression to account for this omitted variable? • Control for x, hence use this
regression: 𝒚𝒊 = 𝜷𝟎 + 𝜷𝟏𝒅𝒊 + 𝜷𝟐𝒙𝒊 + 𝒖𝒊
Why might this still be problematic? (1) Assumes effect of x is linear, and (2) doesn’t really make use of
random assignment, which is really occurring near the threshold
TRADEOFF OF USING NARROW BINS Ideally, we’d like to compare average x right below and right above x’ to
get causal effect; but there is a tradeoff? We won’t have many observations and estimate will be very noisy. A
wider range of x on each side reduces this noise, but increases risk of bias that observations further from
threshold might vary for other reasons (including because of the direct effect of x on y)
Approach with smaller window can be subject to greater noise, but advantages are... • It doesn’t assume
constant effect of treatment for all values of x in the sample; in essence you are estimating local avg.
treatment effect
Less subject to risk of bias because correctly controlling for relationship between x and y is less important in
the smaller window
Non-parametric plot shouldn’t suggest jump in y at other points besides x’ [Why?]
Such a jump would call into question internal validity of RDD; possible that jump
at x’ is driven by something else that is unrelated to treatment
Now, since fuzzy RDD just increases the probability of the treatment, use x>x’ as an IV for treatment.
Notations: di=1 if treated and 0 if not.. We use the threshold indicator (Ti) as the Iv for di. Relevance
condition: indicator affects the probability of di = 1 and Exclusion condition: Ti is unrelated to y conditional on
di and controls f( ). These will be satisfied in earlier assumptions. Example: di = 1 if loan is securitized, Ti = 1 if
FICO score is greater than 620, which increases probability loan is securitized.
Again, f( ) is typically a polynomial function
Unlike sharp RDD, it isn’t as easy to allow functional form to vary above & below
So, if worried about different functional forms, what can you do to mitigate this concern?
Answer = Use a tighter window around event; this is less sensitive to functional form, f(x)
Researcher should ask the following...
• Is there any reason to believe threshold x’ was chosen because of some pre-existing discontinuity in y or lack
of comparability above and below x’ ?
• If so, it is a clear violation of local continuity assumption
• Is there any way or reason why subjects might manipulate their x around threshold?
• Subjects’ (observation unit’s) ability to manipulate x can cause violation of local continuity assumption. With
manipulation, y might exhibit jump around x’ absent treatment because of manipulation.
• Why isn’t subjects’ ability to manipulate x always a problem?
• If they can’t perfectly manipulate it, there will still be randomness in treatment.
• I.e. in small enough bandwidth around x’, there will still be randomness because idiosyncratic shocks will
push some above and some below threshold, even if they are trying to manipulate the x -  to solve this Look
for bunching of observations immediately above or below threshold. Any bunching would suggest
manipulation.
FIELD EXPERIMENTS:
What is an experiment?
• Units of analysis are randomly assigned with known probability to treatment and control conditions. The
assignment is random, not haphazard.
• Ideally, experimenters play an unobtrusive role, reducing the risk of a violation of balancing between
treatment and control.
In a typical experiment:
• Researcher manipulates something in the real world, exposing randomly-assigned groups of people to
different treatments
• Possibly the most fruitful area of research in social sciences, but also greatest ethical challenges since the
experiments can be so powerful and have real-world effects
• Some subjects selected for treatment may refuse, others may switch from control to treatment or from
treatment to control. Hence two types of estimates are possible:
• As treated (AT) analysis compares subjects given the treatment they received. Does not consider treatment
group subject assigned, only which they received
• Intent to Treat (ITT) analysis compares subjects in the groups to which they were randomized, regardless of
whether they received or adhered to the allocated treatment.
CONCERNS REGARDING THE PAPER:
First concern with the analysis is that the coefficient estimate might be biased.
Resolved through: address the predictability of tax changes by focus on unpredictable tax changes using a
model-based approach. In this approach, we performed a textual search analysis of major US newspapers, of
keywords indicative of corporate tax changes to find the number of articles about predictive discussions
mentioning tax-increase related words.
and by using a ‘narrative approach’ by reading through archival records on political and economic
environment around the tax changes and identify those changes that are less likely to be anticipated, as well
as unrelated to local economic conditions. This addresses the concern that while the tax changes we might
have been unpredictable, they could have been driven by the local economic conditions that also
simultaneously affect innovation.
Second concern is that both tax changes and firm innovation could be driven by underlying local economic
conditions, leading to incorrect estimation of the tax effect.
Resolved through: concentrating on firms that are located in contiguous counties on either side of a state
border, so these firms are exposed to similar economic conditions but only one of the states changes taxes.
The narrower geography allows us to control for po- tentially unobserved time-varying economic
heterogeneity across treated and control firms more accurately. These firms should be subject to similar
economic conditions due to their close geographic proximity, but they are subject to different tax changes
However: sample size is significantly reduced to the thousands
First concern with the analysis is that the coefficient estimate might be biased.
Resolved through: address the predictability of tax changes by focus on unpredictable tax changes using a
model-based approach. In this approach, we performed a textual search analysis of major US newspapers, of
keywords indicative of corporate tax changes to find the number of articles about predictive discussions
mentioning tax-increase related words.
and by using a ‘narrative approach’ by reading through archival records on political and economic
environment around the tax changes and identify those changes that are less likely to be anticipated, as well
as unrelated to local economic conditions. This addresses the concern that while the tax changes we might
have been unpredictable, they could have been driven by the local economic conditions that also
simultaneously affect innovation.
Second concern is that both tax changes and firm innovation could be driven by underlying local economic
conditions, leading to incorrect estimation of the tax effect.
Resolved through: concentrating on firms that are located in contiguous counties on either side of a state
border, so these firms are exposed to similar economic conditions but only one of the states changes taxes.
The narrower geography allows us to control for po- tentially unobserved time-varying economic
heterogeneity across treated and control firms more accurately. These firms should be subject to similar
economic conditions due to their close geographic proximity, but they are subject to different tax changes
However: sample size is significantly reduced to the thousands