May 2006

IZA DP No. 2126: A Note on Parametric and Nonparametric Regression in the Presence of Endogenous Control Variables

published in: International Statistical Review, 2008, 76 (2), 214-227

This note argues that nonparametric regression not only relaxes functional form assumptions vis-a-vis parametric regression, but that it also permits endogenous control variables. To control for selection bias or to make an exclusion restriction in instrumental variables regression valid, additional control variables are often added to a regression. If any of these control variables is endogenous, OLS or 2SLS would be inconsistent and would require further instrumental variables. Nonparametric approaches are still consistent, though. A few examples are examined and it is found that the asymptotic bias of OLS can indeed be very large.