Variables in a regression can be endogenous for several reasons including omitted variable biased, measurement error and simultaneity / reverse causation. One example from the previous post was that of unobserved ability in the determination of wages. Since unobserved ability is omitted from a regression of the impact of wages on income it is possible that the return to education is overestimated.
The Hausman Test for endogeneity can help us determine whether or not there is some for of omitted variable biased in this regression:
Since there is a suspicion that education (educ) suffers from omitted variable biased in the form of unobserved ability, we choose fathers and mothers education as instrumental variables. Parents education is likely not to affect the wages of their children but your parents education are good predictor of your education and genetic transmission of intellectual ability. This is why they may potentially be a good…
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