“Theory Development of research and Identification of research problems and conditions.

A Report on
“Theory Development of research”
and
“Identification of research problems and conditions.”

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Comilla University
Department of Accounting and Information Systems

Course name Applied Research Methodology

Course code 506
Task type Term Paper-Report (Group-D)
Marks 10
Report Title Theory Development of research and Identification of research
problems and conditions.
Course teacher Tarik Hossain
Assistant Professor
Department of AIS
Comilla University, Cumilla-3506, Bangladesh.
Students’ name Md. Mominur Rahman (15), Md. Sazzad Hossain (17)
Mohmmad Jubair Hossain (18), Gias Uddin (34)
Safat Ahmed (44), Selina Akter (48), Khokon Hossain (50)
Mst. Aklima Akter (55), Showkat Hossain (56)
Session: 2019-20
Department of AIS
Comilla University, Cumilla-3506, Bangladesh.
Group Name Group-d
Total word count words.
Submission Deadline 7th May, 2021

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Group Members

ID Name Remarks

11606015 Md. Mominur Rahman

11606017 Md. Sazzad Hossain

11606018 Mohmmad Jubair Hossain (Group Leader)

11606034 Gias Uddin

11606044 Safat Ahmed

11606048 Selina Akter

11606050 Khokon Hossain

11606055 Mst. Aklima Akter

11606056 Showkat Hossain

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Table of Contents

Chapter 4 --Theory Development of research

Introduction ..................................................................................................................................... 5

Choice of appropriate theory or theories among various accounting, finance and social science
theories ............................................................................................................................................ 5

Connecting the present study with established theories ................................................................. 8

Justification of Theories ................................................................................................................ 11

Understanding the depth of theories in the light of research interest. .......................................... 12

Conclusion .................................................................................................................................... 12

Chapter 6-- Identification of research problems and conditions

Introduction, .................................................................................................................................. 13

Rank and order conditions of models ........................................................................................... 13

Problem of multicollinearity ......................................................................................................... 16

Problem of Endogeneity, the problem of Hetroskedastricity........................................................ 16

Problem of Auto/Serial- correlation.............................................................................................. 17

Fixed/ Random Effect Test of the Models, ................................................................................... 18

Conclusion .................................................................................................................................... 21

References ..................................................................................................................................... 22

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Chapter 4 --Theory Development of research

Introduction
Theories are explanations of a natural or social behaviour, event, or phenomenon. More formally,
a scientific theory is a system of constructs (concepts) and propositions (relationships between
those constructs) that collectively presents a logical, systematic, and coherent explanation of a
phenomenon of interest within some assumptions and boundary conditions (Mueller and Urbach,
2017).

Theories should explain why things happen, rather than just describe or predict. Note that it is
possible to predict events or behaviours using a set of predictors, without necessarily explaining
why such events are taking place. For instance, market analysts predict fluctuations in the stock
market based on market announcements, earnings reports of major companies, and new data from
the Federal Reserve and other agencies, based on previously observed correlations. Prediction
requires only correlations. In contrast, explanations require causations, or understanding of cause-
effect relationships. Establishing causation requires three conditions: (1) correlations between two
constructs, (2) temporal precedence (the cause must precede the effect in time), and (3) rejection
of alternative hypotheses (through testing). Scientific theories are different from theological,
philosophical, or other explanations in that scientific theories can be empirically tested using
scientific methods.

Choice of appropriate theory or theories among various accounting,

finance and social science theories
Accounting theory: Accounting theory may also be used to explain existing practices to obtain a
better understanding of them. But the most important goal of accounting theory should be to
provide a coherent set of logical principles that form the general frame of reference for the
evaluation and development of sound accounting practices. Accounting theory is that branch of
accounting which consists of the systematic statement of principles and methodology. However,
theory cannot be divorced from practice. The theory underlies practices, explains and attempts to
predict them. Such as:

1. Agency theory (from finance, which is a branch of economics)

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2. Positive accounting theory (from the contracting literature in economics)

3. Grounded theory

4. Structuration theory (from sociology)

5. Constructionist theory (from sociology)

6. Institutional theory (from sociology)

7. Behavioural accounting theory (from the behavioural economics literature)

8. Chaos theory (from the field of mathematics and physics). Chaos theory is used to
understand fraud in the field of forensic accounting.

Accounting does not have its own encompassing theories. But accounting has its own set of
hypotheses which have been very useful, such as the political cost hypothesis, size hypothesis,
debt covenant hypothesis, bonus plans hypothesis, income smoothing hypothesis, and many more.

Finance theories: Financial theories are the building blocks of today's corporate world. "The basic
building blocks of finance theory lay the foundation for many modern tools used in areas such
asset pricing and investment. Many of these theoretical concepts such as general equilibrium
analysis, information economics and theory of contracts are firmly rooted in classical
Microeconomics".

1. The Modern portfolio theory (MPT)

2. Tobin Separation Theorem,
3. Equilibrium Theory,
4. Arbitrage Pricing Theory (APT), and
5. The Efficient Markets Hypothesis.

Social science theories: Social theories are analytical frameworks, or paradigms, that are used to
study and interpret social phenomena. A tool used by social scientists, social theories relate to
historical debates over the validity and reliability of different methodologies (e.g. positivism and
ant positivism), the primacy of either structure or agency, as well as the relationship between
contingency and necessity. Social theory in an informal nature, or authorship based outside of
academic social and political science, may be referred to as "social criticism" or "social

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commentary", or "cultural criticism" and may be associated both with formal cultural and literary
scholarship, as well as other non-academic or journalistic forms of writing.

1. The social evolutionism theory (of which Social Darwinism forms a part),
2. The social cycle theory, and
3. The Marxist historical materialism theory.

Attributes of a Good Theory

Theories are simplified and often partial explanations of complex social reality. As such, there can
be good explanations or poor explanations, and consequently, there can be good theories or poor
theories. How can we evaluate the “goodness” of a given theory? Different criteria have been
proposed by different researchers, the more important of which are listed below:

Logical consistency: Are the theoretical constructs, propositions, boundary conditions, and
assumptions logically consistent with each other? If some of these “building blocks” of a theory
are inconsistent with each other (e.g., a theory assumes rationality, but some constructs represent
non-rational concepts), then the theory is a poor theory (Rizk and Elragal, 2020).

Explanatory power: How much does a given theory explain (or predict) reality? Good theories
obviously explain the target phenomenon better than rival theories, as often measured by variance
explained (R-square) value in regression equations.

Falsifiability: British philosopher Karl Popper stated in the 1940’s that for theories to be valid,
they must be falsifiable. Falsifiability ensures that the theory is potentially disprovable, if empirical
data does not match with theoretical propositions, which allows for their empirical testing by
researchers. In other words, theories cannot be theories unless they can be empirically testable.

Parsimony: Parsimony examines how much of a phenomenon is explained with how few
variables. The concept is attributed to 14th century English logician Father William of Ockham
(and hence called “Ockham’s razor” or “Occam’s razor), which states that among competing
explanations that sufficiently explain the observed evidence, the simplest theory (i.e., one that uses
the smallest number of variables or makes the fewest assumptions) is the best. Explanation of a
complex social phenomenon can always be increased by adding more and more constructs.

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An 'appropriate theory' is one which is used by an educator, even. though it is known to have
inadequacies in terms of the scientific. supporting evidence underlying it and even though it is
known to. offer a simplified view of reality, because it is perceived as a useful. So, by clear
evaluation, one can choose appropriate theory or theories among various accounting, finance and
social science theories.

Connecting the present study with established theories

Attribution theory

Attribution theory refers to the study of the perception or inference of cause. Ideas common to the
several attribution "theories" are that people interpret behavior in terms of its causes and that these
interpretations play an important role in determining reactions to the behavior. Attribution theory
deals with how the social perceiver uses information to arrive at causal explanations for events. It
examines what information is gathered and how it is combined to form a causal judgment”.
Attribution theory is concerned with how ordinary people explain the causes of behavior and
events. For example, is someone angry because they are bad-tempered or because something bad
happened?

Behaviorism learning theory

In the classroom, the behavioral learning theory is key in understanding how to motivate and help
students. Information is transferred from teachers to learners from a response to the right stimulus.
Students are a passive participant in behavioral learning—teachers are giving them the information
as an element of stimulus-response. Teachers use behaviorism to show students how they should
react and respond to certain stimuli. This needs to be done in a repetitive way, to regularly remind
students what behavior a teacher is looking for.

Cognitive Learning

Cognitive learning is an active style of learning that focuses on helping you learn how to maximize
your brain’s potential. It makes it easier for you to connect new information with existing ideas
hence deepening your memory and retention capacity. The ability of the brain’s mental processes
to absorb and retain information through experience, senses, and thought is known as cognition.
There is a young branch of psychology known as cognitive psychology. It is the study of one’s

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internal processes. These are the things going on in your brain, such as thinking, attention, learning,
problem-solving, perception, among others.

Social interaction learning theory

Social learning theory is a theory of learning process and social behavior which proposes that new
behaviors can be acquired by observing and imitating others. ... In addition to the observation of
behavior, learning also occurs through the observation of rewards and punishments, a process
known as vicarious reinforcement.

An instructional theory

A theory that offers explicit guidance on how to better help people learn and develop."[1] It
provides insights about what is likely to happen and why with respect to different kinds of teaching
and learning activities while helping indicate approaches for their evaluation.[2] Instructional
designers focus on how to best structure material and instructional behavior to facilitate learning.

Deductive theory

It is concerned with “developing a hypothesis (or hypotheses) based on existing theory, and then
designing a research strategy to test the hypothesis. It has been stated that “deductive means
reasoning from the particular to the general (Gilgun, 2019). If a causal relationship or link seems
to be implied by a particular theory or case example, it might be true in many cases. A deductive
design might test to see if this relationship or link did obtain on more general circumstances”.
Deductive approach can be explained by the means of hypotheses, which can be derived from the
propositions of the theory. In other words, deductive approach is concerned with deducting
conclusions from premises or propositions. Deduction begins with an expected pattern “that is
tested against observations, whereas induction begins with observations and seeks to find a pattern
within them”.

Inductive theory

the inductive method, well known as “bottom up” scientific method suitable when researcher’s
aim is to generate theories and hypothesis in order to understand why something happens in reality.
Inductive approach of reasoning is usually basic way for building the theories, when researcher by
collecting data scientific way to develop theory as a result of data analysis. The inductive method

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involves three steps in its process referring to researcher’s ability to observe the environment, find
a pattern for observed element and provide generalization about final result of analysis.

Exploratory

Exploratory research is constructed to answer “what” questions, according to Yin (2003), and in
many cases includes new studies which can be result of the appearance of new phenomena or
insufficient knowledge on the subject of any study. This approach is also recommended to approve
researchers’ objectives by gaining new insights about specific issue which fit well and present a
good match to this research. Saunders et. al (2003) states usage of this approach especially for
understanding the problem expressing the main steps to conduct an exploratory research: searching
and studying the literature and talking to experts in the subject through interviews. This concept is
characterized as flexible and adaptable to daily changes as result of new information upcoming or
new hypothesis appearing.

Descriptive

Concept of this research implies design addressed to reveal validate profile of persons, events or
situations. Descriptive concept tends to answer on questions such as “who”, “where” , “how
many”; “how much”. However, “what” question can be included in situation if the research wants
to have u clue about the details of some specific topic or issue. Descriptive research is also well
known as archival research because of the use of arcival records. ( Yin, 2003 ). The concept is
useful and crucial when the researcher achievement focuses on details and description of
phenomena or when it should show prediction about specific findings. Unlike exploratory
approach which is based on qualitative research, descriptive concept implies qualitative way of
analysis using archival records, questionnaire, secondary data, etc. (Saunders et. al., 2003).

Explanatory

Explanatory research is known as casual research and is conducted for answering the “how” and
“why” questions. A casual study is focused on finding casual relationships between variables. This
concept of approach uses qualitative way of research such as case studies, histories, experiments
aiming to describe relationships expressing the cause and effect of particular incident. Explanatory
research design allows using qualitative approach to answer on question “how” and “why” depends

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on sources of relationship between cause and effect. In that way, operational links required
implication of secondary data, statistics. (Yin, 2003; Saunders et. al. 2003).

Justification of Theories
A theory is a way to explain a set of facts. Put another way, if reality were a dot-to-dot picture, a
theory would be a way to connect a set of data dots. However, varying theories connect different
data dots in different ways resulting in a wide variety of pictures and practices. Thus, varying
theoretical perspectives, while based on a set of empirical data, can often advocate different
practices or practical notions. An example would be behavioural learning theory and cognitive
learning theory, both of which are based on solid empirical evidence.

Theoretical justification is a standard adopted to prove that a system has significance, usually
rhetorically (Fischer, 2017). Theoretical justification is privy to all the subtle tools available to
rhetoric. Major types include arguments based on convention, arguments based on absoluteness,
coherency, feasibility, or functionality, and arguments based on probability, correspondence,
likelihood, or common sense.

Working out just how it works takes additional steps, typically involving a link between theory
and a single justification, or in more complex arguments a structured series of defences for a
practical rhetorical result, or a unified combination of logical pieces designed to cohere. The
difference between approaches may thus be approximated as a choice amongst dialectic, in which
the ultimate conclusion is postponed, a linear progression of increasing strength, and a logical
puzzle that somehow explains reality.

Theories are usually used to help design a research question, guide the selection of relevant data,
interpret the data, and propose explanations of the underlying causes or influences of observed
phenomena. Theories are not meant to be eternal entities. They are designed to exist only as long
as they continue to explain facts or connect the relevant data dots. When an abundance of new data
is shown to conflict with established theories, they are discounted or restructured.

A theory is often confused with a hypothesis, which is an untested conjecture. A hypothesis is the
first part of a study or experiment. In a formal quantitative experiment this becomes the basis of a
null hypothesis which is then either supported or rejected by data collected during the experiment.
However, in qualitative or descriptive studies data are collected to answer or explore the question.

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Finally, theories can often be used to justify a practice or procedure for which there may not be
direct research-based evidence.

Understanding the depth of theories in the light of research interest.

Theory is a word that is evocative. It evokes confusion, frustration, trepidation, discomfort, shame,
joy, disorientation, invention and derision. At times researchers will likely experience all of the
above in regard to theory (Reiter, 2017). Part of the joy grappling with theory is this experience of
confusion as one encounters new ideas, or attempts to create ideas that are new by bringing theory
to any problem, or different parts of existing theories together in order to look at a problem a new.
working with theory is invention and this invention is not abstract. Theory is indispensable because
it is intrinsic to the work of education. Though the dissociation of theory with education and
educational research might not be automatic for some. Often when people think about theory it is
often associated with science and its capacity to.

Make things visible or intelligible that are not immediately observable. In the natural sciences
theory often performs this function by making plausible why certain laws-such as ohm's laws or
Boyle's law -are as they are. In the social sciences theory platforms this function by trying to make
plausible why people act as the act or do as they do.

Conclusion
Theories are formulated to explain, predict, and understand phenomena and, in many cases, to
challenge and extend existing knowledge within the limits of critical bounding assumptions. The
theoretical framework is the structure that can hold or support a theory of a research study
(McKenny et al., 2017). The theoretical framework introduces and describes the theory that
explains why the research problem under study exists. Development theory is a collection of
theories about how desirable change in society is best achieved. Such theories draw on a variety
of social science disciplines and approaches. In this article, multiple theories are discussed, as are
recent developments with regard to these theories. Depending on which theory that is being looked
at, there are different explanations to the process of development and their inequalities.

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Chapter 6-- Identification of research problems and conditions

Introduction,
Research comprises creative work undertaken on a systematic basis in order to increase the stock
of knowledge, including knowledge of man, culture and society, and the use of this stock of
knowledge to devise new applications. Research problems are questions that indicate gaps in the
scope or the certainty of our knowledge (Barquero et al., 2019). They point either to problematic
phenomena, observed events that are puzzling in terms of our currently accepted ideas, or to
problematic theories, current ideas that are challenged by new hypotheses. Since research is
problem driven, the first thing to deal in undertaking a study is to identify and determine the
problem to study. Identifying a research problem is important because, as the issue or concern in
a particular setting that motivates and guides the need for conducting a study, it lays the foundation
for an entire project. If the foundation is shaky the entire project is doomed to failure. This is why
novice researchers necessitates absolute caution in the initial stages of a research project.
Professional researchers could easily identify a research problem because they have been quite
familiar with the phenomena in which a problem generally presents itself. By considering the
phenomena which include (1) a difficulty or deficiency to be overcome; (2) a condition to be
improved upon; (3) a gap in knowledge that exists in scholarly literature that is to be filled;
(4) a theory that requires meaningful understanding; or (5) a body of knowledge or views
held in different clime that requires validation or confirmation for local application, professional
researchers could easily recognize suitable problem to students.

Rank and order conditions of models

The order condition of identification

The first decision rule for identification is the so-called order condition. This rule specifies the
necessary conditions for identification and is the more popular one of the two rules that will be
discussed. Unfortunately, it is not a sufficient rule, which means that it is possible that the equation
is undefined even though the order condition says it is identified. However, in a system with only
two equations, the order condition will work well and can be trusted (Smith and McGannon, 2018).

Let,

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M = The number of endogenous variables in the model

K = The number of variables (endogenous and exogenous) in the model excluded from the
equation under consideration.

The order condition states that:

1) |f k = m — 1 => The equation is exactly identified

2) If k >m — 1 => The equation is over identified

3) If k <m — 1 => The equation is under identified

When checking the order condition, you have to do it for each equation in the system.

Consider the following system:

Y1= A0 + A1Y2 + A2X1 + A3X3 + U1..........................(1)

Y2= B0 + B1Y1 + B2X2 + U2............................................(2)

In this example we have two endogenous variables and three exogenous variables with a total of
five variables. M-1 will in this example equal 1 as before since we still have only two endogenous
variables. Will the equations be identified in this case? The first equation contains four variables
which means that one variable has been excluded from the equation, that is, X2 does not appear in
equation 1 and K=1.

Since M-1=K the equation is exactly identified.

The second equation includes three variables which mean that two variables have been excluded.
That is, X1 and X3 are not included in equation 2. That means that K=2, which means that M-1<K
which leads to the conclusion that equation 2 is over identified.

The rank condition of identification

The rank condition is slightly more complicated when dealing with larger systems of equations,
but when using only two equations it is as easy as the order condition. The rank condition is a
necessary and sufficient condition, which means that if we can identify the equations using the
rank condition, we can be sure that the equation really is identified. The rank condition investigates
whether two or more equations are linearly dependent on each other, which would be the case if

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the sum of two equations would equal a third equation in the model. If that is the case it is
impossible to identify all structural parameters. The basic steps in this decision rule is best
described by an example.

Y1= A0+ A1Y3 + A2X1 + A3X3 +

U1.....................................(1)

Y2= B0 + B1Y1 + B2X2 + B3X3 +

U2.....................................(2)

Y3= C0 + C1Y2 + A2X1 + A3X2 +

U3....................................(3)

This system contains three endogenous variables (Y1, Y2, Y3) and three exogenous variables (X1,
X2, X3), which means that we in total has six variables. The first step in checking the rank
condition is to put up a matrix that for each equation mark which of the six variables that are
included (marked with 1) and which that are excluded (marked with 0) from the equation. For our
system we receive the following matrix:

In order to check the rank condition for the first equation we have to proceed as follows: Delete
the first row and collect the columns for those variables of the first equation that were marked with
zero. For equation 1, y and X2 was marked with zero, and if we collect those two columns we
receive:

If this matrix contains less than M-1 rows or columns where all elements are zero, equation 1 will
not be identified. m refers to the number of equation just as in the order condition, which means
that M-1=2. Since we have two rows and two columns and none of them contains only zeros we
conclude that equation 1 is identified.

For equation 2 we proceed in the same way. We delete the second row and collect those columns
where the elements of the second row were marked with a zero. For equation 2 that was the case
for Y3 and X1, which is to say that these two variables was not included in equation 2. The
resulting matrix for this case then becomes:

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It looks in the same way as for equation 1, which means that we have two rows and two columns
that is not only zeros. The same procedure should be done for the third equation and if you do that
you will see that it is identified as well.

When using larger systems, it is quite possible that the order condition says that a particular
equation is identified even though the rank condition says it is not. When that happens, it might
still be possible to generate estimates, but those estimates will not have any economic meaning
since they will represent averages of those equations that are linear combinations of each other.
Hence, you should not be content that you have received identified results just because the order
condition says so and the econometric software generates results for you. When using systems of
more than two equations you should also confirm the identification using the rank condition.

Problem of multicollinearity
Multicollinearity (also collinearity) is a phenomenon in which one predictor variable in a multiple
regression model can be linearly predicted from the others with a substantial degree of accuracy
(Williamson et al., 2019).

Multicollinearity exists whenever an independent variable is highly correlated with one or more
of the other independent variables in a multiple regression equation.

There is some problem of multicollinearity: -

1) Estimated are unbiased consistent & efficient in the presence of multicollinearity.

2) Eliminating variables to solve multicollinearity problems results in estimators that are

bias inconsistent & insufficient.

3) It undermines the statistically significant of an independent variable

4) An independent variable that is very highly correlated with one or more others
independent variable will have a relatively large standard error.

5) the regression coefficient is unstable.

Problem of Endogeneity, the problem of Hetroskedastricity

The Endogeneity Problem

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All probabilistic statistics require conditional independence, namely that the values of the predictor
variables are assigned independently of the dependent variable. The basic problem of endogeneity
occurs when the expanses (X) may be influenced by the explanandum (Y) or both may be jointly
influenced by an unmeasured third. The endogeneity problem is one aspect of the broader question
of selection bias. The endogeneity issue has been debated intensely within the economic growth
literature in terms of the causal relationship between technology and growth. But it applies equally
too many fields.

The best solution in such a situation is to concentrate more on the theoretical elaboration of causal
relations between variables. If we can assume that our estimations are biased because Y affects the
values on X, or because both are jointly attributable to a third underlying force, thinking in
counterfactual terms will force the researcher to identify more precisely the direct or derived causal
connections. If bias can be assumed to come from the assumption of monotonically homogeneous
effects of the X across all nations, the researcher's attention should concentrate on identifying more
precisely the conditional mechanisms that are involved in the causal passage from an X to a Y.

Homoscedasticity

The assumption of homoscedasticity (meaning “same variance”) is central to linear regression

models. Homoscedasticity describes a situation in which the error term (that is, the “noise” or
random disturbance in the relationship between the independent variables and the dependent
variable) is the same across all values of the independent variables.

Problem of Auto/Serial- correlation

Autocorrelation can cause problems in conventional analyses (such as ordinary least squares
regression) that assume independence of observations. In a regression analysis, autocorrelation of
the regression residuals can also occur if the model is incorrectly specified. Autocorrelation refers
to the degree of correlation between the values of the same variables across different observations
in the data.

The concept of autocorrelation is most often discussed in the context of time series data in which
observations occur at different points in time (e.g., air temperature measured on different days of
the month) (Piotrowska et al., 2019). For example, one might expect the air temperature on the
1st day of the month to be more similar to the temperature on the 2nd day compared to the 31st

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day. If the temperature values that occurred closer together in time are, in fact, more similar than
the temperature values that occurred farther apart in time, the data would be autocorrelated.

However, autocorrelation can also occur in cross-sectional data when the observations are related
in some other way. In a survey, for instance, one might expect people from nearby geographic
locations to provide more similar answers to each other than people who are more geographically
distant. Similarly, students from the same class might perform more similarly to each other than
students from different classes. Thus, autocorrelation can occur if observations are dependent in
aspects other than time. Autocorrelation can cause problems in conventional analyses (such as
ordinary least squares regression) that assume independence of observations.

Serial correlation (also called Autocorrelation) is where error terms in a time series transfer from
one period to another. In other words, the error for one time period a is correlated with the error
for a subsequent time period b. For example, an underestimate for one quarter’s profits can result
in an underestimate of profits for subsequent quarters. This can result in a myriad of problems,
including:

★Inefficient Ordinary Least Squares Estimates and any forecast based on those estimates.
An efficient estimator gives the most information about a sample; inefficient estimators
can perform well, but require much larger sample sizes to do so.

★Exaggerated goodness of fit (for a time series with positive serial correlation and an
independent variable that grows over time).

★Standard errors that are too small (for a time series with positive serial correlation and
an independent variable that grows over time).

★T-statistics that are too large.

★False positives for significant regression coefficients. In other words, a regression

coefficient appears to be statistically significant when it is not.

Fixed/ Random Effect Test of the Models,

FIXED-EFFECTS MODEL (Covariance Model, Within Estimator, Individual Dummy
Variable Model, Least Squares Dummy Variable Model):

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Fixed Effects: Use fixed-effects (FE) whenever you are only interested in analyzing the impact of
variables that vary over time. FE explore the relationship between predictor and outcome variables
within an entity (country, person, company, etc.). Each entity has its own individual characteristics
that may or may not influence the predictor variables (for example, being a male or female could
influence the opinion toward certain issue; or the political system of a particular country could
have some effect on trade or GDP; or the business practices of a company may influence its stock
price).When using FE we assume that something within the individual may impact or bias the
predictor or outcome variables and we need to control for this. This is the rationale behind the
assumption of the correlation between entity’s error term and predictor variables. FE remove the
effect of those time-invariant characteristics so we can assess the net effect of the predictors on the
outcome variable. Another important assumption of the FE model is that those time-invariant
characteristics are unique to the individual and should not be correlated with other individual
characteristics. Each entity is different therefore the entity’s error term and the constant (which
captures individual characteristics) should not be correlated with the others. If the error terms are
correlated, then FE is no suitable since inferences may not be correct and you need to model that
relationship (probably using random-effects), this is the main rationale for the Hausman test
(presented later on in this document).

The equation for the fixed effects model becomes:

Y-it =β1Xit +αi +uit [eq.1]

Where

αi (i=1…. n) is the unknown intercept for each entity (n entity-specific intercepts).

– Y it is the dependent variable (DV) where i = entity and

t = time.

–X it represents one independent variable (IV),

–β1 is the coefficient for that IV,

–uit is the error term

“The key insight is that if the unobserved variable does not change over time, then any changes in

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the dependent variable must be due to influences other than these fixed characteristics.” (Stock

and Watson, 2003, p.289-290).

“In the case of time-series cross-sectional data the interpretation of the beta coefficients would be

“…for a given country, as

X varies across time by one unit,

Y increases or decreases by

β units”

(Bartels, Brandom, “Beyond “Fixed Versus Random Effects”: A framework for improving
substantive and statistical analysis of panel, time-series cross-sectional, and multilevel data”,
Stony Brook University, working paper, 2008). Fixed-effects will not work well with data for
which within-cluster variation is minimal or for slow changing variables over time.

A note on fixed-effects

The fixed-effects model controls for all time-invariant differences between the individuals, so the
estimated coefficients of the fixed-effects models cannot be biased because of omitted time-
invariant characteristics…[like culture, religion, gender, race, etc] One side effect of the features
of fixed-effects models is that they cannot be used to investigate time-invariant causes of the
dependent variables. Technically, time-invariant characteristics of the individuals are perfectly
collinear with the person [or entity] dummies. Substantively, fixed-effects models are designed to
study the causes of changes within a person [or entity]. A time-invariant characteristic cannot cause
such a change, because it is constant for each person.” (Underline is mine) Kohler, Ulrich, Frauke
Kreuter, Data Analysis Using Stata, 2nd ed., p.245.

RANDOM-EFFECTS MODEL (Random Intercept, Partial Pooling Model):

Random effects The rationale behind random effects model is that, unlike the fixed effects model,
the variation across entities is assumed to be random and uncorrelated with the predictor or
independent variables included in the model:the crucial distinction between fixed and random
effects is whether the unobserved individual effect embodies elements that are correlated with the
regressors in the model, not whether these effects are stochastic or not” [Green, 2008, p.183] If

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you have reason to believe that differences across entities have some influence on your dependent
variable then you should use random effects. An advantage of random effects is that you can
include time invariant variables (i.e. gender).

In the fixed effects model these variables are absorbed by the intercept.

The random effects model is: Yit = βXit + α + uit + εit [eq.4] 25

Within-entity error Between-entity error PU/DSS/OTR Random Effects Random effects assume
that the entity’s error term is not correlated with the predictors which allows for time-invariant
variables to play a role as explanatory variables. In random-affects you need to specify those
individual characteristics that may or may not influence the predictor variables. The problem with
this is that some variables may not be available therefore leading to omitted variable bias in the
model. RE allows to generalize the inferences beyond the sample used in the model

Conclusion
A research problem is a specific issue, difficulty, contradiction, or gap in knowledge that you will
aim to address in your research. You might look for practical problems aimed at contributing to
change, or theoretical problems aimed at expanding knowledge. Bear in mind that some research
will do both of these things, but usually the research problem focuses on one or the other. The
type of research problem you choose depends on your broad topic of interest and the type of
research you want to do. Your topic is interesting and you have lots to say about it, but this isn’t a
strong enough basis for academic research. Without a well-defined research problem, you are
likely to end up with an unfocused and unmanageable project. You might end up repeating what
other people have already said, trying to say too much, or doing research without a clear purpose
and justification. You need a problem in order to do research that contributes new and relevant
insights. Whether you’re planning your thesis, starting a research paper or writing a research
proposal, the research problem is the first step towards knowing exactly what you’ll do and why.

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