Economics, Data Science, Statistics, Towards Data Science, Business.
X̂ = Π0+Π1(Z)+v Where v is the error term. Step 2) Y = ß0+ß1(X̂)+ε Where ε is the error term. Because our instrumental variable must be exogenous, the values of X̂ that are predicted by the regression of X on Z will be exogeneous too. Therefore, this first step removes the problematic, endogenous