Simulations exogenous shocks

In this document, I run a simulation exercise to illustrate how using a exogenous shocks to avoid confounders may lead to a loss in power and inflated effect sizes. To make these simulations realistic, I emulate a typical study estimating the impact of air pollution reduction shocks on birthweight of newborn babies.

Show packages 
library(tidyverse) 
library(knitr) 
library(fixest)
library(mediocrethemes)
library(broom)
library(tictoc)
library(here)
library(beepr)

set_mediocre_all(pal = "coty")
set.seed(12)

Summary and intuition

A trade-off mediated by the number of treated observations

In the case of studies using exogenous shocks, a confounding / exaggeration trade-off is mediated by the number of (un)treated observations. In some settings, while the number of observations is large, the number of events might be limited. Pinpointing exogenous shocks is never easy and we are sometimes only able to find a limited number of occurrences of this shock or shocks affecting a small portion of the population. More precisely, the number of observations with a non-null treatment status might be small (or conversely the number of non-treated units might be small). In this instance, the variation available to identify the treatment is limited, possibly leading power to be low and exaggeration issues to arise.

Intuition to explain the variation of power with the number of treated observations

The number of treated observations can be decomposed into two parts: the total number of observations times the proportion of observations in the treated group. Of course, if one reduces the total sample size, precision and thus statistical power will decrease. At a fixed total sample size and as commonly discussed in the Randomized Control Trial literature, statistical power is maximized when the proportion of treated observations is equal to the proportion of untreated ones. If we consider a fixed number of observations, decreasing the proportion of treated observations below 0.5 will decrease precision and power. The intuition for this relationship can be given by studying the simple formula for the standard error of the difference between the mean of the outcome for the control and treatment groups. It does not represent the actual standard error of the DiD estimator but can be useful to get an intuition for this trade-off. The formula is the following:

\[se_{\bar{y_T} - \bar{y_c}} = \sqrt{\dfrac{\sigma_T^2}{n_T} + \dfrac{\sigma_C^2}{n_C}}\] where \(n_T\) and \(n_C\) are the number of observation in the treated group and the control group respectively and \(\sigma_T\) and \(\sigma_C\) the standard deviations of the outcome in the treated group and the control group respectively. In many cases, we can assume that \(\sigma_T = \sigma_C = \sigma\). Under this assumption we have:

\[se_{\bar{y_T} - \bar{y_c}} = \dfrac{\sigma}{\sqrt{n}} \times \sqrt{\dfrac{1}{p_T(1-p_T)}}\] where \(n\) is the total number of observations (\(n = n_T + n_C\)) and \(p_T\) the proportion of treated observations.

From this simple formula it is obvious that the standard error of interest increases when \(n\) decreases and that, for \(n\) constant, it is minimized when the proportion of treated is 0.5. Since statistical power is a decreasing function of the variance of an estimator, it will decrease when the proportion of treated diverges from 0.5 and has an infinity limit in 0 and 1, leading to extremely large standard errors when the proportion of treated units is close to 0 or 1. Plotting the function \(x \mapsto \sqrt{\dfrac{1}{x \times(1 - x)}}\) illustrates this:

Show code 
ggplot() + 
  geom_function(fun = \(x) 1/sqrt(x*(1-x))) +
  labs(
    title = "Evolution of s.e. with the proportion of treated units",
    x = "p",
    y = expression(sqrt(frac(1, p(1-p))))
  )

The issue caused by a limited number of treated or control observations does not only affect event studies and DiD but is particularly salient in this case.

An illustrative example

For readability and to illustrate this loss in power, let’s consider an example setting. For this illustration we could use a large variety of Data Genereting Processes (DGP), both in terms of distribution of the variables and of relations between them. I narrow this down to an example setting, considering an analysis of health impacts of air pollution. More precisely, I simulate and analyze the impacts of air pollution reduction in birthweights. Air pollution might vary with other variables that may also affect birthweight (for instance economic activity). Some of these variables might be unobserved and bias estimates of a simple regression of birthweight on pollution levels. A strategy to avoid such issues is to consider exogenous shocks to air pollution such as plant closures, plant openings, creation of a low emission zone or an urban toll, strikes, etc.

Although I consider an example setting for clarity, this confounding / exaggeration trade-off mediated by a number of treated observations arises in other settings.

Modeling choices

To simplify, I make the assumptions described below. Of course these assumptions are arbitrary and I invite interested readers to play around with them.

Many studies in the literature, such as Currie et al. (2015) and Lavaine and Neidell (2017) for instance, aggregate observations to build a panel. I follow this approach and look at the evolution of birthweights in zip codes in time.

For clarity in the explanations, let’s assume that the exogenous shock considered is a permanent plant closure and that this reduces air pollution level. One can also think of it as any permanent exogenous change in air pollution levels. Here, I only estimate a reduced form model and am therefore not interested in modeling the effect of the plant closure on pollution levels. I consider that the plant closure leads to some air pollution reduction and want to estimate the effect of this closure on birth-weight.

For each time period, a zip code is either treated (plant closed) or not treated. Over the whole period, some zip codes experience a plant closure, others do not, either because they do not have a plant that affect their air pollution levels or because their plant did not close.

I consider that the average birthweight in zip code \(z\) at time period \(t\), \(w_{zt}\), depends on a zip code fixed-effect \(\zeta_z\), a time fixed-effect \(\tau_t\) and the treatment status \(T_i\), ie whether a plant is closed in this period or not. For now, I do not simulate omitted variable biases as I consider that the shocks are truly exogenous. Thus, birthweight is defined as follows:

\[w_{zt} = \beta_0 + \beta_1 T_{zt} + \zeta_z + \tau_t + u_{zt}\]

To simplify, I consider the following additional assumptions:

More precisely, I set:

I also create a bunch of useful variables:

Data generation

Generating function

I write a simple function that generates the data. It takes as input the values of the different parameters and returns a data frame containing all the variables for this analysis.

generate_data_shocks <- function(N_z,
                              N_t,
                              length_closed,
                              sigma_u,
                              p_treat,
                              beta_0,
                              beta_1,
                              mu_zip_fe, 
                              sigma_zip_fe,
                              mu_time_fe, 
                              sigma_time_fe
                             ) {
  
  data <- tibble(zip = 1:N_z) |> 
    mutate(in_treatment = (zip %in% sample(1:N_z, floor(N_z*p_treat)))) |> 
    crossing(t = 1:N_t) |>
    group_by(zip) |>
    mutate(zip_fe = rnorm(1, mu_zip_fe, sigma_zip_fe)) |>
    ungroup() |>
    group_by(t) |>
    mutate(time_fe = rnorm(1, mu_time_fe, sigma_time_fe)) |>
    ungroup() %>%
    mutate(
      closed = (t > (N_t - length_closed)/2 & t <= (N_t + length_closed)/2),
      treated = in_treatment & closed, 
      u = rnorm(nrow(.), 0, sigma_u),
      birthweight0 = beta_0 + zip_fe + time_fe + u,
      birthweight1 = birthweight0 + beta_1,
      birthweight = treated*birthweight1 + (1 - treated)*birthweight0
    )
  
  return(data)
}

Calibration and baseline parameters’ values

I set baseline values for the parameters to emulate a somehow realistic observational study`. I get “inspiration” for the values of parameters from Lavaine and Neidell (2017) and Currie et al. (2015). The former investigates the impact of oil refinery strikes in France on birth-weight and gestational age of newborn. The latter studies the impact of air pollution from plants (openings and closures) on WTP (housing value) and health (incidence of low birthweights).

I consider that:

N_z N_t length_closed p_treat sigma_u beta_0 beta_1 mu_zip_fe sigma_zip_fe mu_time_fe sigma_time_fe
2500 60 1 0.1 350 3163 65 33 33 33 33

Here is an example of variables created with the data generating process and baseline parameter values, for 2 zip codes and 8 time periods (not displaying parameters):

Show code 
baseline_param_shocks |>  
  mutate(N_z = 2, N_t = 8, p_treat = 0.5) |> 
  pmap(generate_data_shocks) |>  #use pmap to pass the set of parameters
  list_rbind() |> 
  select(zip, t, treated, starts_with("birthweight"), u, ends_with("fe")) |>  
  kable()
zip t treated birthweight0 birthweight1 birthweight u zip_fe time_fe
1 1 FALSE 3478.285 3543.285 3478.285 279.62773 62.92833 -27.270935
1 2 FALSE 3464.416 3529.416 3464.416 193.51133 62.92833 44.976155
1 3 FALSE 2963.249 3028.249 2963.249 -216.66550 62.92833 -46.013694
1 4 FALSE 2979.283 3044.283 2979.283 -309.09044 62.92833 62.445486
1 5 FALSE 3402.713 3467.713 3402.713 153.79499 62.92833 22.989503
1 6 FALSE 3689.319 3754.319 3689.319 435.42792 62.92833 27.962313
1 7 FALSE 3574.841 3639.841 3574.841 312.53934 62.92833 36.373142
1 8 FALSE 3766.312 3831.312 3766.312 547.38907 62.92833 -7.005873
2 1 FALSE 3501.871 3566.871 3501.871 353.42678 12.71544 -27.270935
2 2 FALSE 3123.960 3188.960 3123.960 -96.73133 12.71544 44.976155
2 3 FALSE 3156.466 3221.466 3156.466 26.76459 12.71544 -46.013694
2 4 TRUE 2940.645 3005.645 3005.645 -297.51630 12.71544 62.445486
2 5 FALSE 2740.060 2805.060 2740.060 -458.64488 12.71544 22.989503
2 6 FALSE 2613.528 2678.528 2613.528 -590.15009 12.71544 27.962313
2 7 FALSE 3476.155 3541.155 3476.155 264.06649 12.71544 36.373142
2 8 FALSE 3044.664 3109.664 3044.664 -124.04605 12.71544 -7.005873

A quick check on a full data set shows that the standard deviation and mean of the birthweight correspond to what we aimed for:

Show code 
ex_data_shocks <- baseline_param_shocks |> 
  pmap_dfr(generate_data_shocks) 

ex_data_shocks_mean <- ex_data_shocks |> 
  summarise(across(.cols = c(birthweight0), mean)) |> 
  mutate(Statistic = "Mean") |> 
  select(Statistic, everything())

ex_data_shocks_sd <- ex_data_shocks |> 
  summarise(across(.cols = c(birthweight0), stats::sd)) |> 
  mutate(Statistic = "Standard Deviation") |> 
  select(Statistic, everything())

ex_data_shocks_mean |> 
  rbind(ex_data_shocks_sd) |> 
  kable()
Statistic birthweight0
Mean 3234.6513
Standard Deviation 353.1789

The treatment allocation when the proportion of treated is 30% is as follows:

Show code 
baseline_param_shocks |> 
  mutate(N_z = 20, N_t = 60, p_treat = 0.1) |>
  pmap_dfr(generate_data_shocks) |> 
  mutate(treated = ifelse(treated, "Treated", "Not treated")) |> 
  ggplot(aes(x = t, y = factor(zip), fill = fct_rev(treated))) + 
  geom_tile(color = "white", lwd = 0.3, linetype = 1) +
  coord_fixed() +
  scale_y_discrete(breaks = c(1, 5, 10, 15, 20)) +
  labs(
    title = "Treatment assignment across time and zip codes",
    x = "Time index", 
    y = "Zip code id", 
    fill = "Treatment status"
  )

Under this set of parameters, a very limited number of observations are treated.

Quick data exploration

I quickly explore a generated data set to get a sense of how the data is distributed. First, I display the distribution of potential outcomes.

Show code 
ex_data_shocks |> 
  pivot_longer(
    cols = c(birthweight0, birthweight1),
    names_to = "potential_outcome",
    values_to = "potential_birthweight"
  ) |> 
  mutate(potential_outcome = factor(str_remove(potential_outcome, "birthweight"))) |> 
  ggplot(aes(x = potential_birthweight, fill = potential_outcome, color = potential_outcome)) +
  geom_density() +
  labs(
    x = "Birthweight (in g)",
    y = "Density",
    color = "Potential Outcome",
    fill = "Potential Outcome",
    title = "Distribution of potential birthweight"
  )

Estimation

I then define a function to run the estimation.

estimate_shocks <- function(data) {
  reg <- data |> 
    mutate(
      zip = as.factor(zip),
      t = as.factor(t),
      treated = as.numeric(treated)
    ) %>% 
    feols(
      data = ., 
      fml = birthweight ~ treated | zip + t
    ) |> 
    broom::tidy() |> 
    rename(p_value = p.value, se = std.error) |> 
    select(-statistic) 
  
  return(reg)
}

Here is an example of an output of this function:

term estimate se p_value
treated 86.95759 22.80669 0.0001407

One simulation

I now run a simulation, combining generate_data_shocks and estimate_shocks. To do so I create the function compute_sim_shocks. This simple function takes as input the various parameters. It returns a table with the estimate of the treatment, its p-value and standard error, the true effect and the proportion of treated units. Note that for now, I do not store the values of the other parameters for simplicity because I consider them fixed over the study.

Show code 
compute_sim_shocks <- function(...) {
  args <- list(...)
  
  data <- generate_data_shocks(...) 
  
  data |>
    estimate_shocks() |> 
    mutate(
      N_z = args$N_z,
      N_t = args$N_t,
      p_treat = args$p_treat,
      true_effect = args$beta_1
    )
}

Here is an example of an output of this function.

term estimate se p_value N_z N_t p_treat true_effect
treated 78.31618 24.95759 0.0017211 2500 60 0.1 65

All simulations

I will run the simulations for different sets of parameters by looping the compute_sim_shocks function over the set of parameters. I thus create a table with all the values of the parameters to test, param_shocks. Note that in this table each set of parameters appears N_iter times as we want to run the analysis \(n_{iter}\) times for each set of parameters.

vect_p_treat <- c(0.002, 0.005, seq(0.01, 0.15, 0.02))
n_iter <- 1000

param_shocks <- baseline_param_shocks |> 
  select(-p_treat) |> 
  crossing(vect_p_treat) |> 
  rename(p_treat = vect_p_treat) |> 
  crossing(rep_id = 1:n_iter) |> 
  select(-rep_id)

I then run the simulations by looping our compute_sim_shocks function on param_shocks using the purrr package (pmap_dfr function).

tic()
sim_shocks <- pmap(param_shocks, compute_sim_shocks, .progress = TRUE) |> 
  list_rbind()
beep()
toc()

saveRDS(sim_shocks, here("Outputs/sim_shocks.RDS"))

Analysis of the results

Quick exploration

First, I quickly explore the results. I plot the distribution of the estimated effect sizes, along with the true effect. The estimator is unbiased and recover, on average, the true effect:

Show code 
sim_shocks <- readRDS(here("Outputs/sim_shocks.RDS"))

sim_shocks |> 
  filter(p_treat %in% sample(vect_p_treat, 4)) |>  
  mutate(
    n_treat = p_treat*N_z*N_t,
    n_treat_name = fct_inseq(paste(n_treat)),
    N_z = paste("Number zip codes: ", str_pad(N_z, 2)),
    N_t = paste("Number periods: ", str_pad(N_t, 2))
  ) |> 
  ggplot(aes(x = estimate)) +
  geom_vline(xintercept = unique(sim_shocks$true_effect)) +
  geom_density() +
  facet_wrap(~ fct_relabel(n_treat_name, \(x) paste(x, "treated")), nrow = 2) +
  labs(
    title = "Distribution of the estimates of the treatment effect",
    subtitle = "For different number of treated observations",
    x = "Estimate of the treatment effect",
    y = "Density",
    caption = "The vertical line represents the true effect"
  )

Computing bias and exaaggeration ratio

We want to compare \(\mathbb{E}\left[ \left| \frac{\widehat{\beta_{red}}}{\beta_1}\right|\right]\) and \(\mathbb{E}\left[ \left| \frac{\widehat{\beta_{red}}}{\beta_1} \right| | \text{signif} \right]\). The first term represents the bias and the second term represents the exaggeration ratio. These terms depend on the true effect size.

source(here("functions.R"))

summary_sim_shocks <- 
  summarise_sim(
    data = sim_shocks |> mutate(true_effect = round(true_effect)), 
    varying_params = c(p_treat, N_t, N_z), 
    true_effect = true_effect
  ) |> 
  mutate(n_treated = p_treat*N_z*N_t)

# saveRDS(summary_sim_shocks, here("Outputs/summary_sim_shocks.RDS"))

Main graph

To analyze our results, I build a unique and simple graph:

Show code 
summary_sim_shocks |> 
  # filter(n_treated < 3000) |> 
  ggplot(aes(x = n_treated, y = type_m)) + 
  # geom_point() +
  geom_line(linewidth = 1.2, color = "#E5C38A") +
  labs(
    x = "Number of treated observations", 
    y = expression(paste("Average  ", frac("|Estimate|", "|True Effect|"))),
    title = "Evolution of bias with the number of treated observations",
    subtitle = "For statistically significant estimates",
    caption = paste("Fixed sample size:",
                    unique(summary_sim_shocks$N_z)*unique(summary_sim_shocks$N_t),
                    "observations \n")
  )

Representativeness of the estimation

We calibrated our simulations to emulate a typical study from this literature. To further check that the results are realistic, we compare the average Signal-to-Noise Ratio (SNR) of our regressions to the range of SNR of existing studies investigating similar questions. Lavaine and Neidell (2017) find SNRs in the range 0.4 to 2.3 in their table 3 and 4. Currie et al. (2015) find SNRs in the range 0.5 to 4 (both in table 6 but SNRs in this range in table 4 and 5 as well).

I find SNR in a similar range or even larger and corresponding to substantial exaggeration ratios.

Show code 
summary_sim_shocks |> 
  select(n_treated, median_snr, type_m) |> 
  kable(
    digits = 2,
    col.names = c("Number of treated observations", "Median SNR", "Bias ratio")
  )
Number of treated observations Median SNR Bias ratio
300 0.94 4.25
750 0.92 3.35
1500 1.07 2.51
4500 1.57 1.68
7500 2.02 1.37
10500 2.38 1.27
13500 2.62 1.16
16500 2.86 1.09
19500 3.07 1.08
22500 3.30 1.05
Currie, Janet, Lucas Davis, Michael Greenstone, and Reed Walker. 2015. “Environmental Health Risks and Housing Values: Evidence from 1,600 Toxic Plant Openings and Closings.” American Economic Review 105 (2): 678–709. https://doi.org/10.1257/aer.20121656.
de Chaisemartin, Clément, and Xavier D’Haultfoeuille. 2022. “Two-Way Fixed Effects and Differences-in-Differences with Heterogeneous Treatment Effects: A Survey.” Working {{Paper}} 29691. Working Paper Series. National Bureau of Economic Research. https://doi.org/10.3386/w29691.
Lavaine, Emmanuelle, and Mathew Neidell. 2017. “Energy Production and Health Externalities: Evidence from Oil Refinery Strikes in France.” Journal of the Association of Environmental and Resource Economists 4 (2): 447–77. https://doi.org/10.1086/691554.

References