  We use variation of test scores measuring closely related skills to isolate
peer effects. The intuition for our identification strategy is that the
difference in closely related scores eliminates factors common to the
performance in either test while retaining idiosyncratic test specific
variation. Common factors include unobserved teacher and group effects as well
as test invariant ability and factors relevant for peer group formation. Peer
effects work through idiosyncratic shocks which have the interpretation of
individual and test specific ability or effort. We use education production
functions as well as restrictions on the information content of unobserved test
taking ability to formalize our approach. An important implication of our
identifying assumptions is that we do not need to rely on randomized group
assignment. We show that our model restrictions are sufficient for the
formulation of linear and quadratic moment conditions that identify the peer
effects parameter of interest. We use Project STAR data to empirically measure
peer effects in kindergarten through third grade classes. We find evidence of
highly significant peer effects with magnitudes that are at the lower end of
the range of estimates found in the literature.
