Problem Set 1:

Panel Data
Joan Llull∗

Advanced Econometric Methods II

Barcelona GSE Economics Program. Winter 2021
1 General instructions

• Delivery instructions: The problem set is due by Wednesday January 20 at 11

AM. Submission is by email to vladislav.morozov@upf.edu. You can work either
individually or in teams of up to three people.
Your submission must consist of one pdf file which contains all your code, discussions,
and derivations. Please make sure that everything is readable, and that discussion is
provided in plain text, not as comments on the code.

• Standard errors: Report standard errors for your estimates (compute them through
the asymptotic formula for the variance of the estimator).

• Stata hints: When solving the PS the first time you may need the commands reg,
xtreg, and xtabond2. There are other alternatives, especially for the GMM case, that
you can search online or through Stata help, if interested. Stata help is quite useful;
type help command to access it.

2 Exercise. Employment equations for UK firms

We are interested in estimating employment equations for UK firms. These equations are
given by:
𝑛𝑖𝑡 = 𝛾0 + 𝛾1 𝑘𝑖𝑡 + 𝛾2 𝑤𝑖𝑡 + 𝛾3 𝑦𝑖𝑡 + (𝜂𝑖 + 𝑣𝑖𝑡 ),
where 𝑛𝑖𝑡 is log of employment of firm 𝑖 in year 𝑡, 𝑘𝑖𝑡 is log of capital, 𝑤𝑖𝑡 is log wages paid
by the firm, and 𝑦𝑖𝑡 is log of output (sales). The unobserved error term, 𝜂𝑖 + 𝑣𝑖𝑡 satisfies the
∗
Departament d’Economia i Història Econòmica. Universitat Autònoma de Barcelona. Facultat
d’Economia, Edifici B, Campus de Bellaterra, 08193, Cerdanyola del Vallès, Barcelona (Spain). E-mail:
joan.llull[at]movebarcelona[dot]eu. URL: http://pareto.uab.cat/jllull.

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baseline assumptions seen in class for the static model unless otherwise noted. Using the
data from file PS1.xls:

1. Estimate the coefficients by OLS.

2. Estimate the coefficients by GLS.

3. Estimate the coefficients with the WG estimator.

4. How do GLS and WG compare? Formally test whether they are different.

Now consider the case in which 𝑣𝑖𝑡 = 𝛼𝑣𝑖𝑡−1 + 𝜀𝑖𝑡 , where 𝜀𝑖𝑡 satisfies the assumptions
seen in class for dynamic models. Except otherwise noted, consider that 𝑘𝑖𝑡 , 𝑤𝑖𝑡 , and 𝑦𝑖𝑡 are
strictly exogenous (i.e. uncorrelated with 𝜀𝑖𝑠 for 𝑠 = 1,...,𝑇 ).

5. Estimate the coefficients using the approach by Anderson and Hsiao.

6. Estimate the coefficients using the approach by Arellano and Bond. Do it using all lags,
at most two, and at most four.

7. Estimate the coefficients using the approach by Arellano and Bover.

8. Implement the Arellano-Bover estimator yourself in Matlab/Stata/language of your

choice. You cannot use prebuilt commands for the estimator, and you can only use
commands for IV regression if you correctly construct the instrument matrix yourself
first

9. How do these three compare? Comment. Test the validity of the assumptions that we
are making.

10. Bonus: Now consider the case in which 𝑘𝑖𝑡 , 𝑤𝑖𝑡 , and 𝑦𝑖𝑡 are predetermined, i.e. the
error term is uncorrelated with current and past values of these variables, but maybe
correlated with future values of them. Discuss the properties of the previous estimators
in this case. Propose a consistent estimator for such a model. Implement it. Comment
on the results.

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3 Exercise. Consistent Estimation Of Coefficients On

Time-Invariant Regressors With Instruments
Based on Hausman, Taylor (1981)1 . Consider the linear panel data model:

𝑦𝑖𝑡 = 𝑥′𝑖𝑡 𝛽 + 𝑧𝑖′ 𝛾 + 𝜂𝑖 + 𝑢𝑖𝑡 (1)

where 𝛽 is 𝑘𝑥 -vector and 𝛾 is a 𝑘𝑧 -vector. Suppose that generally E(𝜂𝑖 |𝑋, 𝑍) ̸= 0, E(𝑢𝑖𝑡 |𝑋, 𝑍) =
0. Our goal is to estimate 𝛾, the coefficients on the time-invariant regressors consistently. Let
the data be iid over 𝑖, 𝑇 fixed.

1. Consider the between regression:

𝑦𝑖· = 𝑥′𝑖· 𝛽 + 𝑧𝑖′ 𝛾 + 𝜂𝑖 + 𝑢𝑖· (2)

∑︀𝑇
where 𝑤𝑖· = 𝑇 −1 𝑡=1 𝑤𝑖𝑡 . Is the OLS estimator of 𝛾 based on this regression consistent?
Why or why not?

(𝑗) (𝑙)
Suppose that we know that E(𝑧𝑖 𝜂𝑖 ) = E(𝑥𝑖 𝜂𝑖 ) = 0 for 𝑗 ∈ {1, . . . , 𝑘𝑧𝑒𝑥 }, 𝑙 ∈ {1, . . . , 𝑘𝑥𝑒𝑥 },
𝑘𝑧0 < 𝑘𝑧 , 𝑘𝑥0 < 𝑘𝑥 , that is, some regressors are known to be orthogonal to the individual effects.
For the within estimator 𝛽ˆ𝑤 define

𝑑ˆ𝑖· = 𝑦𝑖· − 𝑥′𝑖· 𝛽ˆ𝑤 (3)

and consider the regression

𝑑ˆ𝑖· = 𝑧𝑖′ 𝛾 + 𝑣𝑖· (4)

2. Write the residual 𝑣𝑖· in terms of 𝛽ˆ𝑤 , 𝛽, 𝜂𝑖 , and 𝑥𝑖·

3. Propose a consistent IV estimator for 𝛾 using the above equation. What rank conditions
do you need for its existence? Show consistency.

4. Optional (harder): what is the asymptotic distribution of 𝛾? How would you conduct
inference on 𝛾? The properties of 𝑑ˆ𝑖· are changing with 𝑁 because 𝑑ˆ𝑖· is itself generated
with uncertainty, see Pagan (1984)2 for inspiration.

1
J. A. Hausman and W. E. Taylor. Panel Data and Unobservable Individual Effects. Econometrica,
49(6):1377–1398, 1981. doi: 10.2307/1911406.
2
A. Pagan. Econometric Issues in the Analysis of Regressions with Generated Regressors. International
Economic Review, 25(1):221–247, 1984. doi: 10.2307/2648877