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# Discuss the results. Do you expect OLS to over or underestimate the return to education? Explain.

INSTRUCTIONS TO CANDIDATES

1. An introduction discussing the importance of studying the returns to education

For background, read “Economic returns to education: What We Know, What We Dont Know, and Where We Are Going–Some Brief Pointers” by Dickson and Harmon (2011). (You can access the paper on Carmen)

2. Estimate the returns to education using OLS and discuss

Discuss the results. Do you expect OLS to over or underestimate the return to education? Explain.

Discuss why Classical Assumption III is not met

Discuss why a different estimator is needed

3. After introducing the estimator, discuss instrumental variables

Discuss the relevancy and validity of using col4 as an instrument for years of schooling. Test the relevancy of col4 as an instrument for education. Discuss.

– The instrument col4 equals one if a worker lived near a four-year college before the age of 18 and zero otherwise.

Discuss why the instrument may not be exogenous to the wage equation. In other words, what arguments can be made for why location is not entirely exogenous?

Test for weak instruments and discuss

4. Estimate the returns to education using 2SLS, instrumenting years of schooling with proximity to four-year college (col4)

Discuss the results

Does you 2SLS estimate of the return to education make sense given the suspected correlation between educational attainment and the omitted variable?

5. Write a concluding statement discussing the difference between OLS and IV (2SLS) results and the need to address endogeneity in the wage equation.

You will report OLS and 2SLS estimates of the return to education in a single table and include standard errors (in parentheses) below the coefficient estimates. Denote level of significance by placing asterisks on the coefficient estimate, where ∗ denotes 0.10, ∗∗ denotes 0.05, and ∗∗∗ denotes 0.01 levels of significance. Additionally, report the

first-stage coefficient estimate for col4 (and standard error), the sample size (N), and the F-stat associated with the test for weak instruments. Below is the template you need to use for reporting results.

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