Have Instrumental Variables Brought Us Closer to the Truth

A survey of 255 papers that rely on the instrumental variable (IV) approach for identifying causal effects published in the "Big Three" finance journals reveals that IV estimates are larger than their corresponding uninstrumented estimates in about 80% of the studies, regardless of whether the potential endogeneity is expected to create a positive or negative bias based on economic reasoning. Moreover, the magnitude of the IV estimates is, on average, nine times of that of the uninstrumented estimates even when, a priori, the nature of endogeneity should already imply an upward bias of the uninstrumented estimates. This study provides several explanations to this seeming puzzle of "implausibly large" IV estimates in finance research, and proposes best practices for identication-conscientious researchers to produce work that, in the aggregate, will bring us closer to the truth