# How to manually calculate standard errors for instrumental variables?

I am working on statistical inference with instrumental variables (IV) following Wooldridge (2016) Introductory Econometrics, Ch. 15. I am using the Card data set (like the book), with wages as outcome ($$y$$), education as a endogenous continuous treatment ($$x$$) and distance to college as a binary IV ($$z$$).

I want to calculate the standard errors manually, and preferably additionally in matrix form using Mata. So far, I am able to calculate coefficients but I can't seem to obtain the correct standard errors and would be happy for input on this.

I obtain the point estimate for $$\beta_{IV}$$ with the Wald-estimator:

$$\beta_{IV}=\frac{\mathbb{E}[y | z = 1]-\mathbb{E}[y | z = 0]}{\mathbb{E}[x | z = 1]-\mathbb{E}[x | z = 0]}$$,

$$\beta_{IV}=\frac{6.311401-6.155494}{13.52703-12.69801}=.18806$$

Cross-checked with Stata's -ivregress-:

. ivregress 2sls y (x=z), nohe
------------------------------------------------------------------------------
y |      Coef.   Std. Err.      z    P>|z|     [95% Conf. Interval]
-------------+----------------------------------------------------------------
x |   .1880626   .0262826     7.16   0.000     .1365496    .2395756
_cons |   3.767472   .3487458    10.80   0.000     3.083943    4.451001
------------------------------------------------------------------------------


I now want to proceed by calculating the standard errors. Wooldridge (2016, p. 466) writes that standard errors for $$\beta_{IV}$$ is obtained by using the square root of the estimated asymptotic variance, where the latter is obtained by

$$Var(\beta_{IV})=\frac{\sigma^{2}}{SST_{x} \cdot R^{2}_{x,z}}$$

First, $$SST_{x}$$ is the total sum of squares for $$x_{i}$$, calculated by

. use http://pped.org/card.dta, clear // Load Card data set

. rename nearc4 z

. rename educ x

. rename lwage y

. * SSTx
. egen x_bar = mean(x)

. gen SSTx = (x-x_bar)^2

. quiet sum SSTx

. di r(sum)
21562.08


Second, $$R^{2}_{x,z}$$ is obtained from the regression output,

. reg x z, nohe
------------------------------------------------------------------------------
x |      Coef.   Std. Err.      t    P>|t|     [95% Conf. Interval]
-------------+----------------------------------------------------------------
z |    .829019   .1036988     7.99   0.000     .6256912    1.032347
_cons |   12.69801   .0856416   148.27   0.000     12.53009    12.86594
------------------------------------------------------------------------------

. di .829^2
.687241


Finally, $$\sigma^{2}$$ is the error variance given by $$SSE/(n-k-1)$$ where the squared estimate of errors (SSE) is obtained by $$SSE = \sum{(y_{i}-\hat{y_{i}})^{2}}$$. Wooldridge says to use the IV residuals $$\hat{u_{i}}$$ in calculating the error variance,

$$\sigma^{2}=\frac{1}{(n-2)} \sum{\hat{u_{i}}^2}$$

Which I calculate in Stata as,

. quiet reg x z

. predict x_hat
(option xb assumed; fitted values)

. quiet reg y x_hat, nohe

. predict iv_resid
(option xb assumed; fitted values)

. quiet sum iv_resid

. di r(sum)
18848.115

. di (18848.114)^2
3.553e+08

. gen sigma_squared = 3.553e+08

. tabstat sigma_squared, format(%20.2f)

variable |      mean
-------------+----------
sigma_squa~d |        355300000.00
------------------------

. di (1/(3010-2))*355300000
118118.35


Thus, when finally I substitute the values into the equation for the variance of $$\beta_{IV}$$, I get

$$Var(\beta_{IV})=\frac{118118.35}{21562.08 \cdot .687241}=7.9711$$

I then calculate the standard error by following the formula for standard error (e.g. Wooldridge 2016, p. 50):

$$\hat{\sigma} = \sqrt{\hat{\sigma}^{2}} \implies \sqrt{7.9711}=2.8233$$

$$se(\beta_{IV})=\frac{\sigma}{\sqrt{SST_{x}}} \implies \frac{2.8233}{\sqrt{21562.08}}=0.01922$$

I have used quite some time on this and it would really be helpful with some input on what I am doing wrong.

EDIT: Based on the formula provided by Drunk Deriving, I've tried to calculate SE in Mata

. use http://pped.org/card.dta, clear

. keep nearc4 educ lwage id

. rename nearc4 Z

. rename educ X

. rename lwage y

. mata

: y=st_data(.,"y")

: X=st_data(.,"X")

: Z=st_data(.,"Z")

: X = X, J(rows(X),1,1) // Add constant

: Z = Z, J(rows(Z),1,1) // Add constant

: b_iv = luinv(Z'*X)*Z'*y

: e=y-X*b_iv

: v=luinv(Z'*X)*Z'e*e'*Z*luinv(Z'*X)

: xmean = mean(X)

: tss_x = sum((X :- xmean) :^ 2)

: se=sqrt(v)/tss_x

: t=b_iv:/se

: p=2*ttail(rows(X)-cols(X),abs(t))

: b_iv,se,t,p
1             2             3             4             5             6             7
+---------------------------------------------------------------------------------------------------+
1 |  .1880626042             .   1.69178e-17             .   1.11162e+16             .             0  |
2 |  3.767472015   4.17102e-17             .   9.03251e+16             .             0             .  |
+---------------------------------------------------------------------------------------------------+

: end


HEre it is an option

use http://pped.org/card.dta, clear
keep nearc4 educ lwage id
rename nearc4 z
rename educ x
rename lwage y
bysort z: sum y x

gen byte one=1
mata:
y=st_data(.,"y")
x=st_data(.,"x one")
z=st_data(.,"z one")
xh=z*invsym(z'*z)*z'*x
biv=invsym(xh'*xh)*xh'*y
biv2=luinv(z'*x)*z'*y
//residuals
re=y-x*biv
vcv=sum(re:^2)/(rows(y))*invsym(xh'*xh)
vcv
end
ivregress 2sls y (x=z),
matrix list e(V)


the main difference with your previous code is how errors are defined (re=y-x*biv) and that, ivregress Stata does not adjust for degrees of freedom. otherwise if you use the following:

mata:sum(re:^2)/(rows(y)-2)*invsym(xh'*xh)


you need to compare it to

ivregress 2sls y (x=z), small


Since this is just identified, the formula is pretty straight forward. Let $$X$$ be the matrix of the independent variables, $$Z$$ is the matrix of instruments, and $$e$$ be vector or errors, then $$Var(\beta_{IV})=(Z’X)^{-1}Z’ee’Z(Z’X)^{-1}.$$

• Thank you Drunk Deriving! I have edited the question to include how I am trying to solve this in Mata code. Would you have any input on how I could edit my code to obtain correct SE's? If you see where it goes wrong in my original manual approach, that would be great too. I plan to use this for instructional purposes in the future, and I think the step-by-step approach may be more intuitive than matrix form for some audiences. – Tarjei W. Havneraas Jun 15 at 5:15

Thank you for your immensely helpful reply @Fcold. I was hoping someone could point out where my code was mistaken. To be on the sure side, I just want to repeat the code in matrix form so I understand it correctly:

(1) Obtain predicted $$x$$-values from the first stage:

$$\hat{X}=Z(Z'Z)^{-1}Z'X$$

(2.a.) Obtain IV-coefficients:

$$\beta_{IV}=(\hat{X}'\hat{X})^{-1}\hat{X}y$$

(2.b.) Alternatively, use:

$$\beta_{IV2}=(Z'X)^{-1}Z'y$$

(3) Calculate residuals:

$$\hat{u}=y-X\beta_{IV}$$

(4) Calculate the variance-covariance matrix:

$$C= \frac{\sum\hat{u}^{2}}{n(\hat{X}'\hat{X})^{-1}}$$

(5) Obtain standard errors for coefficients:

$$se(\beta_{IV})=\sqrt{C}$$

I added the last part as I see this provides the correct standard errors, but please correct me if I'm wrong.

gen byte one=1
mata:
y=st_data(.,"y")
x=st_data(.,"x one")
z=st_data(.,"z one")
xh=z*invsym(z'*z)*z'*x
biv=invsym(xh'*xh)*xh'*y
biv2=luinv(z'*x)*z'*y
//residuals
re=y-x*biv
vcv=sum(re:^2)/(rows(y))*invsym(xh'*xh)
se=sqrt(vcv)
t=(biv:/se)
end

• yes this is correct. with just 1 minor point. $C=n^{-1}\sum{\hat{u}^2 * (\hat{X}'\hat{X})^{-1} }$. Also, in retrospect, I think your code was correct for the equivalent to "robust" standard errors. – Fcold Jun 16 at 15:36
• Thanks for your input which really helped in getting a better grasp of this. – Tarjei W. Havneraas Jun 16 at 19:20