Simultaneous equation models are a type of statistical model in the form of a set of linear simultaneous equations. They are often used in econometrics. One can estimate these models equation by equation; however, estimation methods that exploit the system of equations, such as generalized method of moments (GMM) and instrumental variables estimation (IV) tend to be more efficient.^{[1]}
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✪ Simultaneous Equations Models – An Introduction

✪ Simultaneous Equation Models  I (Simple Model Setup)

✪ Simultaneous Equations and Instrumental Variables

✪ Simultaneous Equations Models – The Identification Problem

✪ Simultaneous Equation Model  Simultaneous Equation Bias  Regression
Transcription
Contents
Structural and reduced form
Suppose there are m regression equations of the form
where i is the equation number, and t = 1, ..., T is the observation index. In these equations x_{it} is the k_{i}×1 vector of exogenous variables, y_{it} is the dependent variable, y_{−i,t} is the n_{i}×1 vector of all other endogenous variables which enter the i^{th} equation on the righthand side, and u_{it} are the error terms. The “−i” notation indicates that the vector y_{−i,t} may contain any of the y’s except for y_{it} (since it is already present on the lefthand side). The regression coefficients β_{i} and γ_{i} are of dimensions k_{i}×1 and n_{i}×1 correspondingly. Vertically stacking the T observations corresponding to the i^{th} equation, we can write each equation in vector form as
where y_{i} and u_{i} are T×1 vectors, X_{i} is a T×k_{i} matrix of exogenous regressors, and Y_{−i} is a T×n_{i} matrix of endogenous regressors on the righthand side of the i^{th} equation. Finally, we can move all endogenous variables to the lefthand side and write the m equations jointly in vector form as
This representation is known as the structural form. In this equation Y = [y_{1} y_{2} ... y_{m}] is the T×m matrix of dependent variables. Each of the matrices Y_{−i} is in fact an n_{i}columned submatrix of this Y. The m×m matrix Γ, which describes the relation between the dependent variables, has a complicated structure. It has ones on the diagonal, and all other elements of each column i are either the components of the vector −γ_{i} or zeros, depending on which columns of Y were included in the matrix Y_{−i}. The T×k matrix X contains all exogenous regressors from all equations, but without repetitions (that is, matrix X should be of full rank). Thus, each X_{i} is a k_{i}columned submatrix of X. Matrix Β has size k×m, and each of its columns consists of the components of vectors β_{i} and zeros, depending on which of the regressors from X were included or excluded from X_{i}. Finally, U = [u_{1} u_{2} ... u_{m}] is a T×m matrix of the error terms.
Postmultiplying the structural equation by Γ^{ −1}, the system can be written in the reduced form as
This is already a simple general linear model, and it can be estimated for example by ordinary least squares. Unfortunately, the task of decomposing the estimated matrix into the individual factors Β and Γ^{ −1} is quite complicated, and therefore the reduced form is more suitable for prediction but not inference.
Assumptions
Firstly, the rank of the matrix X of exogenous regressors must be equal to k, both in finite samples and in the limit as T → ∞ (this later requirement means that in the limit the expression should converge to a nondegenerate k×k matrix). Matrix Γ is also assumed to be nondegenerate.
Secondly, error terms are assumed to be serially independent and identically distributed. That is, if the t^{th} row of matrix U is denoted by u_{(t)}, then the sequence of vectors {u_{(t)}} should be iid, with zero mean and some covariance matrix Σ (which is unknown). In particular, this implies that E[U] = 0, and E[U′U] = T Σ.
Lastly, the identification conditions require that the number of unknowns in this system of equations should not exceed the number of equations. More specifically, the order condition requires that for each equation k_{i} + n_{i} ≤ k, which can be phrased as “the number of excluded exogenous variables is greater or equal to the number of included endogenous variables”. The rank condition of identifiability is that rank(Π_{i0}) = n_{i}, where Π_{i0} is a (k − k_{i})×n_{i} matrix which is obtained from Π by crossing out those columns which correspond to the excluded endogenous variables, and those rows which correspond to the included exogenous variables.
Estimation
Twostages least squares (2SLS)
The simplest and the most common^{[2]} estimation method for the simultaneous equations model is the socalled twostage least squares method, developed independently by Theil (1953) and Basmann (1957). It is an equationbyequation technique, where the endogenous regressors on the righthand side of each equation are being instrumented with the regressors X from all other equations. The method is called “twostage” because it conducts estimation in two steps:^{[3]}
 Step 1: Regress Y_{−i} on X and obtain the predicted values ;
 Step 2: Estimate γ_{i}, β_{i} by the ordinary least squares regression of y_{i} on and X_{i}.
If the i^{th} equation in the model is written as
where Z_{i} is a T×(n_{i} + k_{i}) matrix of both endogenous and exogenous regressors in the i^{th} equation, and δ_{i} is an (n_{i} + k_{i})dimensional vector of regression coefficients, then the 2SLS estimator of δ_{i} will be given by^{[3]}
where P = X (X ′X)^{−1}X ′ is the projection matrix onto the linear space spanned by the exogenous regressors X.
Indirect least squares
Indirect least squares is an approach in econometrics where the coefficients in a simultaneous equations model are estimated from the reduced form model using ordinary least squares.^{[4]}^{[5]} For this, the structural system of equations is transformed into the reduced form first. Once the coefficients are estimated the model is put back into the structural form.
Limited information maximum likelihood (LIML)
The “limited information” maximum likelihood method was suggested M. A. Girshick in 1947,^{[6]} and formalized by T. W. Anderson and H. Rubin in 1949.^{[7]} It is used when one is interested in estimating a single structural equation at a time (hence its name of limited information), say for observation i:
The structural equations for the remaining endogenous variables Y_{−i} are not specified, and they are given in their reduced form:
Notation in this context is different than for the simple IV case. One has:
 : The endogenous variable(s).
 : The exogenous variable(s)
 : The instrument(s) (often denoted )
The explicit formula for the LIML is:^{[8]}
where M = I − X (X ′X)^{−1}X ′, and λ is the smallest characteristic root of the matrix:
where, in a similar way, M_{i} = I − X_{i} (X_{i}′X_{i})^{−1}X_{i}′.
In other words, λ is the smallest solution of the generalized eigenvalue problem, see Theil (1971, p. 503):
K class estimators
The LIML is a special case of the Kclass estimators:^{[9]}
with:
Several estimators belong to this class:
 κ=0: OLS
 κ=1: 2SLS. Note indeed that in this case, the usual projection matrix of the 2SLS
 κ=λ: LIML
 κ=λ  α (nK): Fuller (1977) estimator. Here K represents the number of instruments, n the sample size, and α a positive constant to specify. A value of α=1 will yield an estimator that is approximately unbiased.^{[10]}
Threestage least squares (3SLS)
The threestage least squares estimator was introduced by Zellner & Theil (1962).^{[11]} It can be seen as a special case of multiequation GMM where the set of instrumental variables is common to all equations.^{[12]} If all regressors are in fact predetermined, then 3SLS reduces to seemingly unrelated regressions (SUR). Thus it may also be seen as a combination of twostage least squares (2SLS) with SUR.
Using crossequation restrictions to achieve identification
In simultaneous equations models, the most common method to achieve identification is by imposing withinequation parameter restrictions.^{[13]} Yet, identification is also possible using cross equation restrictions.
To illustrate how cross equation restrictions can be used for identification, consider the following example from Wooldridge ^{[13]}
y_{1} = γ_{12} y_{2} + δ_{11} z_{1} + δ_{12} z_{2} + δ_{13} z_{3} + u_{1}
y_{2} = γ_{21} y_{1} + δ_{21} z_{1} + δ_{22} z_{2} + u_{2}
where z's are uncorrelated with u's and y's are endogenous variables. Without further restrictions, the first equation is not identified because there is no excluded exogenous variable. The second equation is just identified if δ_{13}≠0, which is assumed to be true for the rest of discussion.
Now we impose the cross equation restriction of δ_{12}=δ_{22}. Since the second equation is identified, we can treat δ_{12} as known for the purpose of identification. Then, the first equation becomes:
y_{1}  δ_{12} z_{2} = γ_{12} y_{2} + δ_{11} z_{1} + δ_{13} z_{3} + u_{1}
Then, we can use (z_{1},z_{2},z_{3}) as instruments to estimate the coefficients in the above equation since there are one endogenous variable (y_{2}) and one excluded exogenous variable (z_{2}) on the right hand side. Therefore, cross equation restrictions in place of withinequation restrictions can achieve identification.
Applications in social science
Across fields and disciplines simultaneous equation models are applied to various observational phenomena. These equations are applied when phenomena are assumed to be reciprocally causal. The classic example is supply and demand in economics. In other disciplines there are examples such as candidate evaluations and party identification^{[14]} or public opinion and social policy in political science;^{[15]}^{[16]} road investment and travel demand in geography;^{[17]} and educational attainment and parenthood entry in sociology or demography.^{[18]} The simultaneous equation model requires a theory of reciprocal causality that includes special features if the causal effects are to be estimated as simultaneous feedback as opposed to onesided 'blocks' of an equation where a researcher is interested in the causal effect of X on Y while holding the causal effect of Y on X constant, or when the researcher knows the exact amount of time it takes for each causal effect to take place, i.e., the length of the causal lags. Instead of lagged effects, simultaneous feedback means estimating the simultaneous and perpetual impact of X and Y on each other. This requires a theory that causal effects are simultaneous in time, or so complex that they appear to behave simultaneously; a common example are the moods of roommates.^{[19]} To estimate simultaneous feedback models a theory of equilibrium is also necessary – that X and Y are in relatively steady states or are part of a system (society, market, classroom) that is in a relatively stable state.^{[20]}
See also
Notes
 ^ Wooldridge, Jeffrey M. Introductory econometrics: A modern approach. Nelson Education, 2015. chapter 16
 ^ Greene (2003, p. 398)
 ^ ^{a} ^{b} Greene (2003, p. 399)
 ^ Park, SB. (1974) "On Indirect Least Squares Estimation of a Simultaneous Equation System", The Canadian Journal of Statistics / La Revue Canadienne de Statistique, 2 (1), 75–82 JSTOR 3314964
 ^ Vajda, S.; Valko, P.; Godfrey, K.R. (1987). "Direct and indirect least squares methods in continuoustime parameter estimation". Automatica. 23 (6): 707–718. doi:10.1016/00051098(87)900276.
 ^ First application by Girshick, M. A.; Haavelmo, Trygve (1947). "Statistical Analysis of the Demand for Food: Examples of Simultaneous Estimation of Structural Equations". Econometrica. 15 (2): 79–110.
 ^ Anderson, T.W.; Rubin, H. (1949). "Estimator of the parameters of a single equation in a complete system of stochastic equations". Annals of Mathematical Statistics. 20 (1): 46–63. doi:10.1214/aoms/1177730090. JSTOR 2236803.
 ^ Amemiya (1985, p. 235)
 ^ Davidson & Mackinnon (1993, p. 649)
 ^ Davidson & Mackinnon (1993, p. 649)
 ^ Kmenta, Jan (1986). "System Methods of Estimation". Elements of Econometrics (Second ed.). New York: Macmillan. pp. 695–701.
 ^ Hayashi, Fumio (2000). "MultipleEquation GMM". Econometrics. Princeton University Press. pp. 276–279.
 ^ ^{a} ^{b} Wooldridge, J.M., Econometric Analysis of Cross Section and Panel Data, MIT Press, Cambridge, Mass.
 ^ Page, Benjamin I.; Jones, Calvin C. (19791201). "Reciprocal Effects of Policy Preferences, Party Loyalties and the Vote". American Political Science Review. 73 (4): 1071–1089. doi:10.2307/1953990. ISSN 00030554. JSTOR 1953990.
 ^ Wlezien, Christopher (19950101). "The Public as Thermostat: Dynamics of Preferences for Spending". American Journal of Political Science. 39 (4): 981–1000. doi:10.2307/2111666. JSTOR 2111666.
 ^ Breznau, Nate (20160701). "Positive Returns and Equilibrium: Simultaneous Feedback Between Public Opinion and Social Policy". Policy Studies Journal. 45 (4): 583–612. doi:10.1111/psj.12171. ISSN 15410072.
 ^ Xie, F.; Levinson, D. (20100501). "How streetcars shaped suburbanization: a Granger causality analysis of land use and transit in the Twin Cities". Journal of Economic Geography. 10 (3): 453–470. doi:10.1093/jeg/lbp031. ISSN 14682702.
 ^ Marini, Margaret Mooney (19840101). "Women's Educational Attainment and the Timing of Entry into Parenthood". American Sociological Review. 49 (4): 491–511. doi:10.2307/2095464. JSTOR 2095464.
 ^ Wong, ChiSum; Law, Kenneth S. (19990101). "Testing Reciprocal Relations by Nonrecursive Structuralequation Models Using CrossSectional Data". Organizational Research Methods. 2 (1): 69–87. doi:10.1177/109442819921005. ISSN 10944281.
 ^ 2013. “Reverse Arrow Dynamics: Feedback Loops and Formative Measurement.” In Structural Equation Modeling: A Second Course, edited by Gregory R. Hancock and Ralph O. Mueller, 2nd ed., 41–79. Charlotte, NC: Information Age Publishing
References
 Amemiya, Takeshi (1985). Advanced econometrics. Cambridge, Massachusetts: Harvard University Press. ISBN 9780674005600.
 Basmann, R. L. (1957). "A generalized classical method of linear estimation of coefficients in a structural equation". Econometrica. 25 (1): 77–83. doi:10.2307/1907743. JSTOR 1907743.
 Davidson, Russell; MacKinnon, James G. (1993). Estimation and inference in econometrics. Oxford University Press. ISBN 9780195060119.
 Fuller, Wayne (1977). "Some Properties of a Modification of the Limited Information Estimator". Econometrica. 45 (4): 939–953. doi:10.2307/1912683. JSTOR 1912683.
 Greene, William H. (2002). Econometric analysis (5th ed.). Prentice Hall. ISBN 9780130661890.
 Maddala, G. S. (2001). "Simultaneous Equations Models". Introduction to Econometrics (Third ed.). New York: Wiley. pp. 343–390. ISBN 9780471497288.
 Theil, Henri (1971). Principles of Econometrics. New York: John Wiley.
 Sargan, Denis (1988). Lectures on Advanced Econometric Theory. Oxford: Basil Blackwell. pp. 68–89. ISBN 9780631149569.
 Zellner, Arnold; Theil, Henri (1962). "Threestage least squares: simultaneous estimation of simultaneous equations". Econometrica. 30 (1): 54–78. doi:10.2307/1911287. JSTOR 1911287.
External links
 About.com:economics Online dictionary of economics, entry for ILS
 Lecture on the Identification Problem in 2SLS, and Estimation on YouTube by Mark Thoma