Scandinavian Working Papers in Economics

Working Paper Series,
IFAU - Institute for Evaluation of Labour Market and Education Policy

No 2008:22: Proxying ability by family background in returns to schooling estimations is generally a bad idea

Erik Mellander () and Sofia Sandgren-Massih ()
Additional contact information
Erik Mellander: IFAU - Institute for Labour Market Policy Evaluation, Postal: P O Box 513, SE-751 20 Uppsala, Sweden
Sofia Sandgren-Massih: Department of Economonics, Uppsala University, Postal: P O Box 513, SE-751 20 Uppsala, Sweden

Abstract: A regression model is considered where earnings are explained by schooling and ability. It is assumed that schooling is measured with error and that there are no data on ability. Regressing earnings on observed schooling then yields an estimate of the return to schooling that is subject to positive omitted variable bias (OVB) and negative measurement error bias (MEB). The effects on the OVB and the MEB from using family background variables as proxies for ability are investigated theoretically and empirically. The theoretical analysis demonstrates that the impact on the OVB is uncertain, while the MEB invariably increases in magnitude. The empirical analysis shows that the MEB generally dominates the OVB. As the measurement error increases and/or more family background variables are added, the total bias rapidly becomes negative, driving the estimated return further and further away from the true value.

Keywords: Missing data; proxy variables; measurement error; consistent estimates of omitted variable bias and measurement error bias

JEL-codes: C13; C20; C52; J31

28 pages, October 20, 2008

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