Structural equation modeling with small sample sizes using two-stage ridge least-squares estimation

In covariance structure analysis, two-stage least-squares (2SLS) estimation has been recommended for use over maximum likelihood estimation when model misspecification is suspected. However, 2SLS often fails to provide stable and accurate solutions, particularly for structural equation models with small samples. To address this issue, a regularized extension of 2SLS is proposed that integrates a ridge type of regularization into 2SLS, thereby enabling the method to effectively handle the small-sample-size problem. Results are then reported of a Monte Carlo study conducted to evaluate the performance of the proposed method, as compared to its nonregularized counterpart. Finally, an application is presented that demonstrates the empirical usefulness of the proposed method.