Instrumental variables estimates of peer effects in social networks.

Estimating peer effects with observational data is very difficult because of contextual confounding, peer selection, simultaneity bias, and measurement error, etc. In this paper, I show that instrumental variables (IVs) can help to address these problems in order to provide causal estimates of peer effects. Based on data collected from over 4000 students in six middle schools in China, I use the IV methods to estimate peer effects on smoking. My design-based IV approach differs from previous ones in that it helps to construct potentially strong IVs and to directly test possible violation of exogeneity of the IVs. I show that measurement error in smoking can lead to both under- and imprecise estimations of peer effects. Based on a refined measure of smoking, I find consistent evidence for peer effects on smoking. If a student's best friend smoked within the past 30 days, the student was about one fifth (as indicated by the OLS estimate) or 40 percentage points (as indicated by the IV estimate) more likely to smoke in the same time period. The findings are robust to a variety of robustness checks. I also show that sharing cigarettes may be a mechanism for peer effects on smoking. A 10% increase in the number of cigarettes smoked by a student's best friend is associated with about 4% increase in the number of cigarettes smoked by the student in the same time period.