Estimating Decision-Relevant Comparative Effects Using Instrumental Variables

Instrumental variables methods (IV) are widely used in the health economics literature to adjust for hidden selection biases in observational studies when estimating treatment effects. Less attention has been paid in the applied literature to the proper use of IVs if treatment effects are heterogeneous across subjects. Such a heterogeneity in effects becomes an issue for IV estimators when individuals' self-selected choices of treatments are correlated with expected idiosyncratic gains or losses from treatments. We present an overview of the challenges that arise with IV estimators in the presence of effect heterogeneity and self-selection and compare conventional IV analysis with alternative approaches that use IVs to directly address these challenges. Using a Medicare sample of clinically localized breast cancer patients, we study the impact of breast-conserving surgery and radiation with mastectomy on 3-year survival rates. Our results reveal the traditional IV results may have masked important heterogeneity in treatment effects. In the context of these results, we discuss the advantages and limitations of conventional and alternative IV methods in estimating mean treatment-effect parameters, the role of heterogeneity in comparative effectiveness research and the implications for diffusion of technology.