DECOMPOSITION OF VARIABLES AND CORRELATED MEASUREMENT ERRORS

This paper examines the bias in the OLS estimators when the regressors have measurement errors correlated in a particular manner. When a var iable is decomposed into two components but only one of them is observ ed with error, the induced measurement error in the other component is identical but has the opposite sign. This specific correlation patter n enables us to assess the direction of the bias in the OLS estimators from observed data. In the standard EIV case this would require knowl edge of the relative variances of the measurement errors. Examples of this type of decomposition in applied work are presented.