Proxy variables o What if model is misspecified because no data is available on an important x variable? e It may be possible to avoid omitted variable bias by using a proxy variable a proxy variable must be related to the unobservable variable- for example: x? 80 +83x3+v3, where implies unobserved e Now suppose we just substitute x3 for x3* Economics 20- Prof anderson 8Economics 20 - Prof. Anderson 8 Proxy Variables What if model is misspecified because no data is available on an important x variable? It may be possible to avoid omitted variable bias by using a proxy variable A proxy variable must be related to the unobservable variable – for example: x3* = d0 + d3 x3 + v3 , where * implies unobserved Now suppose we just substitute x3 for x3*