The pitfalls of ignoring outliers in instrumental variables estimations: An application to the deep determinants of development

Abstract

The extreme sensitivity of instrumental variables (IV) estimators to outliers is a crucial problem too often neglected or poorly dealt with. We address this issue by making the practitioner aware of the existence, usefulness, and inferential implications of robust-to-outliers instrumental variables estimators. We describe how the standard IV estimator can be made robust to outliers, provide a brief description of alternative robust IV estimators, simulate the behaviour of both the standard IV estimator and each robust IV estimator in presence of different types of outliers, and conclude by replicating a celebrated study on the deep determinants of development in order to establish the danger of ignoring outliers in an IV model.