INSTRUMENTAL VARIABLES - A STUDY OF IMPLICIT BEHAVIORAL ASSUMPTIONS USED IN MAKING PROGRAM EVALUATIONS

This paper considers the use of instrumental variables to estimate the mean effect of treatment on the treated, the mean effect of treatment on randomly selected persons and the local average treatment effect. It examines what economic questions these parameters address. When res ponses to treatment vary, the standard argument justifying the use of instrumental variables fails unless person-specific responses to treat ment do not influence decisions to participate in the program being ev aluated. This requires that individual gains from the program that can not be predicted from variables in outcome equations do not influence the decision of the persons being studied to participate in the progra m. In the likely case in which individuals possess and act on private information about gains from the program that cannot be fully predicte d by variables in the outcome equation, instrumental variables methods do not estimate economically interesting evaluation parameters. Instr umental variable methods are extremely sensitive to assumptions about how people process information. These arguments are developed for both continuous and discrete treatment variables and several explicit econ omic models are presented.