Abstract :
This paper investigates the asymptotic size properties of a two-stage test in the linear
instrumental variables model when in the first stage a Hausman (1978) specification
test is used as a pretest of exogeneity of a regressor. In the second stage, a simple
hypothesis about a component of the structural parameter vector is tested, using a
t-statistic that is based on either the ordinary least squares (OLS) or the twostage
least squares estimator (2SLS), depending on the outcome of the Hausman
pretest. The asymptotic size of the two-stage test is derived in a model where weak
instruments are ruled out by imposing a positive lower bound on the strength of the
instruments. The asymptotic size equals 1 for empirically relevant choices of the
parameter space. The size distortion is caused by a discontinuity of the asymptotic
distribution of the test statistic in the correlation parameter between the structural
and reduced form error terms. The Hausman pretest does not have sufficient power
against correlations that are local to zero while the OLS-based t-statistic takes on
large values for such nonzero correlations. Instead of using the two-stage procedure,
the recommendation then is to use a t-statistic based on the 2SLS estimator or,
if weak instruments are a concern, the conditional likelihood ratio test by Moreira
(2003).
