The Yule-Frisch-Waugh-Lovell Theorem for Linear Instrumental Variables Estimation

In this paper, I discuss three aspects of the Frisch-Waugh-Lovell theorem. First, I show that the theorem holds for linear instrumental variables estimation of a multiple regression model that is either exactly or overidentified. I show that with linear instrumental variables estimation: (a) coefficients on endogenous variables are identical in full and partial (or residualized) regressions; (b) residual vectors are identical for full and partial regressions; and (c) estimated covariance matrices of the coefficient vectors from full and partial regressions are equal (up to a degree of freedom correction) if the estimator of the error vector is a function only of the residual vectors and does not use any information about the covariate matrix other than its dimensions. Second, I show that: (a) the theorem applies to conditional maximum likelihood estimators of linear models with Gaussian errors, (b) the theorem applies in large samples to the K-class of estimators for which K approaches 1, which includes the limited information maximum likelihood (LIML) estimator, and (c) while the theorem does not apply in general to linear GMM estimators, it does apply to the two step optimal linear GMM estimator. Third, I trace the historical and analytical development of the theorem and suggest that it be renamed as the Yule-Frisch-Waugh-Lovell (YFWL) theorem to recognize the pioneering contribution of the statistician G. Udny Yule in its development.