R Guide for Introductory Econometrics for Finance by Brooks Chris

Author:Brooks, Chris [Brooks, Chris]
Language: eng
Format: epub
Publisher: Cambridge University Press
Published: 2019-03-27T16:00:00+00:00

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where ‘returns’ are stock returns – see Brooks (2019) for details.

It is evident that there is feedback between the two equations since the inflation variable appears in the returns equation and vice versa. Two-stage least squares (2SLS) is therefore the appropriate technique to use. To do this we need to specify a list of instruments, which would be all of the variables from the reduced form equation. In this case, the reduced form equations would be:

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For this example we will be using the ‘macro.RData’ file and the package AER , which provides the function ivreg() to run instrumental variable regressions. The function works in a similar fashion to the known lm function with the additional argument instruments . Hence, we put the exogenous variables on the right hand side of the formula and either define the instruments using the argument directly or after the exogenous variables separated by |. Also, as with other models, we can call them using the summary function to see the results in the following way.

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