Endogenous vs Exogenous Variables Explained With Examples & Why It’s Important For Machine Learning

by | Apr 19, 2023 | Data Science, Machine Learning

Endogenous and exogenous variables are two important concepts. In machine learning, endogenous variables are the variables that are directly influenced by other variables within the system being modelled. These variables are typically the outputs or dependent variables of the model. On the other hand, exogenous variables are variables that are not directly influenced by other variables in the system. These variables are typically the inputs or independent variables of the model.

Identifying and differentiating between endogenous and exogenous variables in machine learning is essential. This can help create better models by reducing the risk of overfitting or including irrelevant variables.

This article will explain both concepts, provide examples, and show how they can be used in regression models, what possible problems occur and how to fix them.

Exogenous

What is an exogenous variable?

An exogenous variable is a variable in a statistical or mathematical model that is not influenced by other variables. It is often referred to as an independent or predictor variable, as it is used to predict the values of other variables in the model.

Exogenous variables are typically considered to be outside the control of the model and are often used to explain the behaviour of the dependent variable. For example, income could be viewed as an exogenous variable in a consumer spending model. It is not influenced by consumer spending but is used to explain why it may increase or decrease.

Exogenous variables are essential in many fields, including economics, finance, and social sciences. Analysts can better understand the factors influencing outcomes by identifying and analysing exogenous variables and making more accurate predictions.

Example of an exogenous variable

Let’s say you want to build a model to predict how many ice cream cones a particular ice cream shop will sell on a given day. For example, you could use variables like temperature, day of the week, and advertising spending to predict the number of cones sold.

The temperature could be considered an exogenous variable because the number of cones sold does not directly influence it.

The temperature could be considered an exogenous variable because the number of cones sold does not directly influence it.

In this scenario, temperature could be considered an exogenous variable because the number of cones sold does not directly influence it. The temperature may be a good predictor variable, as it could affect how many people are out and about and in the mood for ice cream, but the number of cones sold will not affect the temperature.

On the other hand, the number of cones sold would be considered an endogenous variable because it is directly influenced by the other variables in the model, such as temperature and advertising spending. As the temperature and advertising spending increase or decrease, the number of cones sold will likely follow suit.

Endogenous

What is an endogenous variable?

An endogenous variable is a variable in a statistical or mathematical model that is directly influenced by other variables in the model. It is often referred to as a dependent or outcome variable, as it is predicted or explained by other variables in the model.

Endogenous variables are typically influenced by exogenous variables (i.e., variables outside the model) and other endogenous variables within the model. For example, in an economic growth model, an investment could be considered an endogenous variable, as it is directly influenced by other variables within the model, such as government policies and consumer confidence.

Endogenous variables are essential in many fields, including economics, social sciences, and engineering. By analysing endogenous variables, researchers and analysts can better understand the relationships between variables and predict how changes to one variable affect others within the model.

Example of an endogenous variable

Let’s say you want to build a model to predict the graduation rates of high school students. To predict graduation rates, you might use variables like family income, parental education, and student attendance.

graduation rates would be considered an endogenous variable because it is directly influenced by the other variables in the model

Graduation rates would be considered an endogenous variable because it is directly influenced by the other variables in the model.

In this scenario, graduation rates would be considered an endogenous variable because it is directly influenced by the other variables in the model, such as family income and student attendance. For example, as family income increases, students may have access to more resources to help them succeed in school, leading to higher graduation rates. Similarly, as student attendance increases, students may be more likely to meet academic requirements and ultimately graduate.

Family income and student attendance could be exogenous variables because graduation rates do not directly influence them. While they may affect the likelihood of graduation, changes to graduation rates will not directly affect family income or student attendance.

Endogenous and exogenous variables in regression models

Endogenous and exogenous variables are essential concepts in regression analysis. Regression analysis is a statistical technique that is used to model the relationship between one or more independent (exogenous) variables and a dependent (endogenous) variable.

In regression analysis, the endogenous variable is the variable of interest, and the exogenous variables are the predictors used to explain the variation in the endogenous variable.

Endogenous variables are crucial in regression analysis because they are modelled variables, and the analysis aims to estimate the relationship between the endogenous variable and the exogenous variables.

Exogenous variables are also crucial in regression analysis because they help to explain the variation in the endogenous variable. Researchers can better understand the factors influencing the endogenous variable by including relevant exogenous variables in the regression model.

For example, in a regression analysis that aims to model the relationship between student test scores (endogenous variable) and variables such as class size, teacher experience, and student socioeconomic status (exogenous variables), class size, teacher experience, and student socioeconomic status would be the exogenous variable. In contrast, student test scores would be the endogenous variable.

Overall, endogenous and exogenous variables are fundamental to regression analysis. They help establish the relationship between variables and provide valuable insights into the factors influencing the variable of interest.

Endogeneity

Endogeneity is a common problem in regression analysis, where an endogenous variable is correlated with the error term and can lead to biased estimates and invalid inference. In addition, other variables influence endogenous variables in the model, and their inclusion in the regression model can create endogeneity problems.

Endogeneity can arise in several situations, such as:

  1. Omitted variable bias: This occurs when a relevant variable related to the dependent and independent variables is not included in the regression model. The omitted variable may influence the dependent and independent variables, leading to endogeneity.
  2. Reverse causality: This occurs when the dependent variable and the independent variable have a bidirectional relationship, and the dependent variable influences the independent variable. In this situation, the independent variable becomes endogenous.
  3. Simultaneity: This occurs when the dependent variable and the independent variable are jointly determined, meaning that they influence each other at the same time.
  4. Measurement error: This happens when there is a discrepancy between the actual value of a variable and its measured value. Measurement error can create spurious correlations between variables and lead to endogeneity.
  5. Selection bias: This occurs when the sample used in the analysis is not representative of the population being studied. Selection bias can lead to endogeneity if the sample is not randomly selected and the selection criteria are related to the dependent variable.

An example of endogeneity

An example of endogeneity can be the relationship between education and income. Education is a common predictor of income in regression models, but other factors, such as family background, natural ability, and motivation, may influence education. These factors may also influence income, creating endogeneity between education and income.

If we include education as a predictor variable in a regression model that includes income as the dependent variable, we may find a positive relationship between education and income. However, this relationship may be biased if education is endogenous. Omitted variable bias may occur if we fail to include variables affecting education and income, such as the family background. Reverse causality may also arise if income influences education, such as when individuals pursue higher education to increase their income.

To address endogeneity in this example, we can use instrumental variables correlated with education but uncorrelated with the error term, such as the distance to the nearest college or the number of college graduates in the local community. Then, we can use these instrumental variables to estimate the effect of education on income without bias.

Addressing endogeneity in regression analysis 

To address this issue, we can use several remedies, including:

  1. Instrumental Variables (IV) Regression: This technique involves using an instrumental variable to create a valid estimation of the endogenous variable. The instrumental variable must satisfy two conditions: correlated with the endogenous variable and uncorrelated with the error term.
  2. Two-Stage Least Squares (2SLS) Regression: This type of IV regression involves two stages. In the first stage, the instrumental variable estimates the endogenous variable. In the second stage, the estimated endogenous variable is used as a predictor variable in the regression model.
  3. Control Variables: We can also include relevant control variables in the regression model to help reduce the endogeneity bias. Control variables are exogenous variables related to both the dependent and endogenous variables but not correlated with the error term.
  4. Natural Experiments: We can also use natural experiments to identify exogenous variations in the endogenous variable. A natural experiment is an event that occurs naturally and creates a variation in the endogenous variable that is exogenous and not influenced by the error term.

Overall, addressing endogeneity in regression analysis is vital to ensure that the estimates are accurate and the inference is valid. Researchers must choose the appropriate remedy based on the characteristics of the data and the research question.

The importance of endogenous and exogenous variables in machine learning

The importance of endogenous and exogenous variables in machine learning lies in their ability to help create accurate and effective predictive models. Machine learning models can better predict outcomes and provide valuable insights by understanding the relationships between these variables.

Endogenous variables are crucial in machine learning, as they are the variables the model attempts to predict or explain. Therefore, machine learning models can identify the most critical factors influencing the outcome variable and create a more accurate predictive model by analysing the relationships between endogenous and exogenous variables.

Exogenous variables, on the other hand, provide valuable contextual information that can help explain endogenous variables’ behaviour. By including relevant exogenous variables in a machine learning model, we can better understand the factors that influence the outcome variable and improve the accuracy of the predictions.

Using endogenous and exogenous variables in machine learning is essential for creating accurate and effective predictive models. By identifying and analysing these variables, machine learning models can provide valuable insights and inform decision-making across various fields.

Conclusion Endogenous vs Exogenous

In conclusion, endogenous variables can cause biased estimates and invalid inferences in regression analysis. Endogeneity can arise for various reasons, such as omitted variable bias, reverse causality, simultaneity, measurement error, and selection bias.

Addressing endogeneity in regression analysis is vital to obtain accurate estimates and valid inferences. We can use various remedies, such as instrumental variables, two-stage least squares regression, control variables, and natural experiments, to address endogeneity and obtain unbiased estimates.

By carefully considering the potential sources of endogeneity and selecting appropriate remedies, we can improve the validity and reliability of our regression analysis.

About the Author

Neri Van Otten

Neri Van Otten

Neri Van Otten is the founder of Spot Intelligence, a machine learning engineer with over 12 years of experience specialising in Natural Language Processing (NLP) and deep learning innovation. Dedicated to making your projects succeed.

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