Panel Data for Learing

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Panel Data for Learing

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2. The generalized least squares estimator

3. Fixed effects model

4. Random Effects model

consecutive periods:

(Yit , Xit )

panel of size N T .

observed in years 2000, 2001, 2002, so T = 3.

observed monthly from 1998:01 up to 2001:12, so T = 48.

Note that:

T small, N large survey data on individuals/firms for a small

number of waves.

For 8 South-American countries we want to model the Real GDP per

capita in 1985 prices (=Rgdl) in function of the following explicative

variables.

You find the data in the file penn.wmf, already in Eviews format.

We are in particular interested in the effect of Openness on economic

growth.

define the cross-section identifiers. These identifiers are those parts of the

names of the series identifying the cross-section.

2. Open the XR-variables as a group and make a plot of them. Compute them

in log-difference, using the PoolGenr menu of the pool object and

logdifXR?=dlog(XR?). The ? will be substituted by every cross-section

identifier. Plot the transformed variables.

3. Compute the medians of the variable I? for the different countries (use

View/descriptive statistics within the Pool object.) Compute now the average

value of I? for every year.

4. Estimate the regression model for Brazil, using /Quick/estimate equation

and specifying in Eviews the equation

dlog(rgdp bra) c dlog(pop bra) i bra g bra dlog(xr bra) open bra

5. Now we want to pool the data of all countries, to increase the sample size.

Use, within the pooled object, /Estimate, and specify: dependent

variable=dlog(rgdp?); common coefficients=c dlog(pop?) i? g? dlog(xr?)

open?. This is a pooled regression model.

6. Pooling the data ignores the fact that the data originate from different

countries. Dummy variables for the different countries need to be added. This

can be done by specifying the constant term as a cross section specific

coefficient. We obtain a fixed effect panel data model. Discuss the

regression output.

7. The fixed effect panel data model assumes that the effect of openness is the

same of all countries. How could you relax this assumption?

8. Test whether all country effects are equal (to know how Eviews labels the

coefficients, use View/Representation), using a Wald test. The country

effects are called the fixed effects, and if there are significantly different then

there is unobserved heterogeneity.

estimator

Yi = Xi + i (i = 1, . . . , n)

with

is

Has the smallest variance among all estimators (for normal

errors) and smallest variance among all linear estimators.

OLS =

n

X

Xi Xi

i=1

!1

n

X

i=1

Xi Yi

E.g. for panel data:

Cross-sectional heteroscedasticity

...

not optimal anymore.

Yi = Xi + i (i = 1, . . . , n)

with

One can still use OLS (not even a bad idea), if one uses

heteroscedasticity)

10

and optimal and is given by

GLS =

n X

n

X

i=1 j=1

wij Xi Xj

n X

n

X

i=1 j=1

wij Xi Yj ,

wij = (1 )ij .

11

1. Compute OLS and the residuals

riOLS = Yi Xi OLS .

2. Use the above residuals to estimate the ij . [This will require

some additional assumptions on the structure of ]

Compute then the GLS estimator with estimated weights wij .

The above scheme can be iterated fully iterated GLS estimator.

12

Theoretical Example

Our sample of size n = 20 consists of two groups of equal size (e.g.

men and women). There is no correlation among the observations,

but we think that the variances of the error terms for men and

women might be of different size.

[The error terms contains the omitted and unobserved variables. We

might indeed think that their size is different for women than for

men, e.g. when regressing salary on individual characteristics]

2

i2 = ii = M

for i = 1, . . . , 10

i2 = ii = F2

for i = 11, . . . , 20

ij = 0 for i 6= j .

13

1. Compute the OLS estimator and the residuals riOLS .

2. Estimate

2

10

20

X

1 X OLS 2

1

=

(ri

) and

F2 =

(riOLS )2 .

10 i=1

10 i=11

1

w

i = 2

1

(i = 1, . . . , 10) and w

i = 2

GLS =

n

X

wi Xi Xi

i=1

14

!1

n

X

i=1

(i = 11, . . . , 20)

wi Xi Yi

Let it be the error term of a panel data regression model, with

1 i n, and 1 t T.

Three different specifications are common:

1. V ar(it ) = 2 and all covariances between error terms are zero.

OLS can be applied (no weighting).

2. V ar(it ) = i2 and all covariances between error terms are zero.

We have cross-sectional heteroscedasticity. GLS can be applied

(cross-section weights):

3. V ar(it ) = i2 , Cov(it , jt ) = ij , all other covariances zero. We

allow now for contemporaneous correlation between

cross-sections. GLS can be applied (SUR weights).

15

1. Have a look at the residuals (View/residuals/Graphs) within the

pool object). Compute the covariance and the correlation matrix

of the residuals (i) Is there cross-sectional heteroscedasticity?

(ii) Is there contemporaneous correlation?

2. Estimate now the model with the appropriate GLS estimator.

Are the results depending a lot on the weighting scheme?

3. Is there still serial correlation present in the residuals, i.e.

(cross)-correlation at leads and lags? Hence, is the model

capturing the dynamics in the data?

16

Yit = Xit

+ i + it

every unit i.

heterogeneity in the model.

contain the remaining omitted variables.

17

H0 : 1 = . . . = N :=

(Test for redundant fixed effects)

In case H0 holds, there is no unobserved heterogeneity, and the model

reduces to the pooled regression model:

+ + it

Yit = Xit

estimated , see figure:

18

15

Cross Section 1

Cross Section 2

10

Pooled Regression

Cross Section 3

19

LSDV estimation

LSDV=Least Squares Dummy Variable estimation

Rewrite the model as

+ it ,

j

Estimate model by OLS or GLS (weighting).

If necessary, use White/Newey West type of Standard Errors (also if

GLS is used, see later).

20

Compute averages of Xit and Yit within each group of

i. and Yi.

cross-sectional unit X

Y

it

Yi.

=

=

Xit

+ i + it

+ i + i.

X

i.

i. ) + (it i. )

(Yit Yi. ) = (Xit X

Regress the centered Yit on the centered Xit by OLS.

By centering, the fixed effects are eliminated !

One can show that the within group estimator is identical to LSDV.

21

Comments

1. If a variable Xit is constant in time for all cross-sections, the FE

model cannot be estimated.

Why?

2. The fixed effects model can be rewritten with a common

intercept included as

Yit = Xit

+ + i + it ,

and

1 + 2 + . . . + N = 0.

Obviously, we have i = + i , and is the average of the fixed

effects.

22

3. One can add time effects (or period effects) in the model:

+ i + t + it ,

Yit = Xit

cross-sections, at every time point t.

The time effects capture the business cycle.

23

(typical for micro-applications), but serial correlation or period

heteroscedasticity is present (within each unit), then OLS can be

made more precise/efficient:

(a) V ar(it ) = t2 and all covariances between error terms are zero.

We have period heteroscedasticity. GLS can be applied

(Period weights):

(b) V ar(it ) = t2 , Cov(it , is ) = ts , all other covariances zero. We

allow for serial correlation. GLS can be applied (Period

weights).

24

We consider investment data for 10 American firms from 1935-1954,

and consider the model

for 1 i N = 10, and 1 t T = 20. The variables are

25

1. Have a look at the data in the Excel File. Write up the number of

observations, the number of variables, and the upper left cell of the data

matrix. Close the Excel file, create an unstructured Workfile and read in the

data (Proc/Import/Read Text Lotus Excel).

2. To apply a panel structure, double click on the Range: line at the top of

the workfile window, or select Proc/Structure/Resize Current Page. Select

Dated Panel, and enter the appropriate variables as Date Series and as

Cross Section ID series.

3. Open the investment series. Explore the Descriptive Statistics and tests

menu.

26

4. Use View/Graph to (i) Make a line plot of the time series for every cross

section (ii) Make boxplots of the distribution of investment over the different

cross sections and over time.

5. Use Quick/Estimate Equation to estimate the fixed effects model. Specify

the equation inv c cap value and use Panel Options to indicate that you use

fixed effects.

6. Interpret your outcome. Would it be useful to add period effects? Test

whether they this is necessary with View/Fixed Random Effects testing.

7. Select an appropriate weighting scheme within Panel Options. Interpret your

outcome.

27

Model

Yit = c + Xit

+ it

it = i + vit .

It is the permanent component of the error term.

vit a noise term N (0, v2 ).

It is the idiosyncratic component of the error term.

28

uncorrelated at all leads and lags, within and across cross sections.

The random effects are uncorrelated among cross-sections.)

allows for correlation within cross-section units:

For every i and t 6= s:

2

Cov(it , is ) = Cov(i + vit , i + vis ) =

2

Var(it ) = Var(i + vit ) =

+ v2 .

29

2

.

= Corr(it , is ) = 2

+ v2

RE-estimator.

Different methods are existing to make GLS feasible.

30

The random effect i needs to be uncorrelated with the X -variables.

This is a strong assumption. If not, there is an endogeneity problem,

and the RE-estimator is inconsistent.

H0 : Corr(i , Xit ) = 0

The Hausman test compares two estimators: the FE (always

consistent) and the RE estimator (consistent under H0 ).

One rejects H0 if the difference between the two estimators is large.

31

appropriate (HO not needed).

random sample from a population, then random effects model

becomes attractive:

It is a parsimonious model, that captures within

group-correlation.

(For N large, FE requires estimation of many parameters)

(i) Sample of 1000 children coming from 30 different schools

(ii) Sample of 1000 persons from 20 different villages

...

32

Using robust standard errors (or coefficient covariance) might be

appropriate. This only affects the SE, not the estimators.

1. White cross section: robust to V ar(it ) = i2 and Cov(it , jt ) = ij .

[robust to cross-section heteroscedasticity and contemporenous correlation

among cross sections; appropriate if N << T .]

[robust to serial correlation within cross-section and changing variances over

time; appropriate if cross-sections are random sample and T << N .]

2

3. White diagonal: robust to V ar(it ) = it

[robust to all forms of heteroscedasticity, but not robust for any type of

correlation over time of across cross-section.]

33

model was:

IN Vit = i1 V ALit + i2 CAPit + i + it

1. Estimate the model as a random effects model.

2. What is the within-group correlation?

3. Perform the Hausman test. (View/Fixed random effects

testing/Correlated random effects)

4. Compute different types of robust SE. How is this affecting the

results?

34

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