Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 494: On Omitted Variable Bias and Measurement Error in Returns to Schooling Estimates

Erik Mellander ()
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Erik Mellander: The Research Institute of Industrial Economics, Postal: Box 5501, 114 85 Stockholm, Sweden

Abstract: Lam and Schoeni (1993) consider an equation where earnings are explained by schooling and ability. They assume that ability data are lacking and that schooling is measured with error. The estimate obtained by regressing earnings on schooling thus contains omitted variable bias (OVB), which is positive, and measurement error bias (MEB), which is negative. Adding a family background variable to proxy for ability is claimed to: i) decrease the OVB towards, but not below, zero and ii) make the MEB even more negative. This note claims that while ii) is true, even in the context of multiple family background variables, i) is in general incorrect. The OVB may increase in magnitude and/or change sign. Conditions are provided under which i) holds. A simulation procedure is suggested that will yield consistent estimates of the total bias and its components, conditional upon values on the true return and the measurement error variance.

Keywords: Missing data; Proxy variables; Measurement error; Partial correlations; Simulations

JEL-codes: C13; C20; J31

19 pages, March 5, 1998

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