Why is there endogeneity in this specification?

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  • Thread starter Thread starter operationsres
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SUMMARY

The discussion centers on the endogeneity present in an Ordinary Least Squares (OLS) regression model, specifically due to the differenced Leverage independent variable being correlated with the error term. This correlation arises primarily from omitted variable bias. Additionally, an autoregressive relationship between leverage and returns is identified as a contributing factor to endogeneity in the model specification.

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  • Knowledge of endogeneity and its implications in econometrics
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  • Concept of autoregressive models
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operationsres
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Hi guys,

I am trying to learn why there is endogeneity in the following OLS estimated regression model:


2wgfams.jpg



A big part would be because the differenced Leverage independent variable is correlated with the error term, largely because of omitted variables.

But I'm looking for reasons as to why the way the model is specified is conducive to endogeneity?

Thanks.
 
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Hi operationsres

I'd say another reason might be an autoregressive behavior between the leverage and the returns.
 

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