PBAF 529 Tobit Models and Heckman Selection: Dealing with selection bias Cheat Sheet Tobit Models Created by James Tobin, Tobit models are similar to a linear equation, but they also include a normally distributed error term. The dependent variable is censored, which means that Tobit models set parameters around it. Tobit models address problems with data due to your measurement or dataset not capturing all the information (i.e. ceiling effects or censored data). Example A: Effect of GRE Scores on Graduate School admissions GRE scores have a maximum and a minimum (200 and 800, respectively). Two people may have the same score on the maximum or minimum range, but not have the same abilities. Example B: Effect of schooling on wages You are trying to measure the effect of schooling on peoples’ wage and you only have data on the wages of those who are working. You are missing the data for those who are not working. How Tobit models work for example B, only lower censored: y i= observed outcome variable of interest (wages) Because the distribution is truncated, the outcome is only observed above a certain threshold (we only know the wages of people who work). To get around this problem we assume that there is some latent outcome variable yi*, which is related to the observed outcomes in the following way. (You can think of yi* as a variable that captures the outcome variable of interest for all observations in the sample, even for those where one wasn’t observed in reality.) (Wages for people who did not work). 𝑦𝑖∗ 𝑦𝑖 = { 0 𝑖𝑓𝑦𝑖∗ > 0 𝑖𝑓 𝑦𝑖∗ ≤ 0 where 𝑦𝑖∗ = 𝛽𝑥𝑖 +∈𝑖 and 𝑥𝑖 = explanatory variables 𝛽 = parameters specifying relationshipbetweeen x and y ∈= error term Alex Chew and Amelia Vader 1 PBAF 529 What is the probability of being “observed”? Censored data leads to biased estimates using regular OLS. You can try to correct for this error by introducing an adjustment to your equation that takes into account the probability of being “observed”(in our example B this would mean the probability of working and therefore having a wage above zero). Conceptually, this implies the following relationship between the relationship between the outcome variable of interest, the explanatory variables, and the observed outcomes in your sample. E(y)=F(y)E(y*) where E(y)=Expected value of Outcome of interest F(y)=Probability of being observed E(y*) =Expected value of outcome of interest conditional upon being observed Maximum Likelihood Estimator Implementing the “adjustment” to correct for selection bias requires using a “maximum likelihood estimation.” This means using an equation to determine the probability of being “observed” in the sample. Although a number of maximum likelihood estimations exist, one of the more common is the Heckman Selection estimator. Heckman Selection Estimator Heckman selection is a statistical model developed by James Heckman to correct for selection bias. It is a means of correcting for not having a randomly selection sample (i.e. your sample isn’t representative of the group you want to study). Heckman selection model is a type of Tobit model How Heckman works 1. Selection Equation (Maximum Likelihood Estimator) First, you create calculate the selection equation, or the probability that someone is working (their propensity to be in the sample): Make a probit model for determinants of being “observed” and record a likelihood estimate for each observation. 2. Add exclusionary variables This can make your selection equation better. Otherwise, the selection may be weak. For example B, effect of schooling on wages, pick exclusionary variables would affect the likelihood of working and not affect wage rate (e.g. having younger children at home, student status) Alex Chew and Amelia Vader 2 PBAF 529 3. OLS regression Then, use a statistically adjusted value (inverse mills ratio) calculated using your selection equation as an Independent Variable in the OLS regression for your outcome of interest. Heckman treats the selection bias as an omitted variable bias. Plug in a statistically adjusted version of the likelihood estimate from the selection equation as an explanatory variable in an OLS regression. The result is a better estimate or fit compared with running it with those without wage information, or running it with a smaller sample of only those for whom you have wage information. Key Assumptions Error terms for selection equation and OLS regression are jointly normal. Vi in equation is normally distributed and E [∈i | Vi] is linear When to NOT use a Tobit: If you have heteroskedaticity in the error term. When you don’t have an instrumental variable or exclusion restriction (without these you are going off of assumptions about the distribution). When you don’t have a theory about the selection bias. Your model is only as good as the assumptions you are make about the bias. If you have colinearity problems. If ρ parameter is very sensitive Resources Tobit How to read a Tobit Output: http://www.ats.ucla.edu/stat/stata/output/stata_tobit.htm How to use a Tobit model in Stata: http://en.wikibooks.org/wiki/Stata/Tobit_and_Selection_Models Information on the five variations of Tobit models: http://en.wikipedia.org/wiki/Tobit_model Information on censoring problems: http://en.wikipedia.org/wiki/Censoring_%28statistics%29 Tobit model setup in Stata: Microeconometrics Using Stata, Cameron and Trivedi. pg. 536 Heckman Microeconometrics Using Stata, Cameron and Trivedi. Pg. 558 How to use Heckman in Stata: http://www.stata.com/features/heckman-probit/heckprob.pdf Basic information: http://en.wikipedia.org/wiki/Heckman_correction Powerpoint on Heckman: http://rtm.wustl.edu/GMMC/heckman.pdf Alex Chew and Amelia Vader 3