## Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

**Three estimation methods:
**

1. “n-1 binary regressors” OLS regression

2. “Entity-demeaned” OLS regression

3. “Changes” specification (only works for T = 2)

• These three methods produce identical estimates

of the regression coefficients, and identical

standard errors.

• We already did the “changes” specification (1988

minus 1982) – but this only works for T = 2 years

• Methods #1 and #2 work for general T

• Method #1 is only practical when n isn’t too big

8-1

1. “n-1 binary regressors” OLS regression

Y

it

= β

0

+ β

1

X

it

+ γ

2

D2

i

+ … + γ

n

Dn

i

+ u

i

(1)

where D2

i

=

1 for =2 (state #2)

0 otherwise

i

¹

'

¹

etc.

• First create the binary variables D2

i

,…,Dn

i

• Then estimate (1) by OLS

• Inference (hypothesis tests, confidence intervals)

is as usual (using heteroskedasticity-robust

standard errors)

• This is impractical when n is very large (for

example if n = 1000 workers)

8-2

2. “Entity-demeaned” OLS regression

The fixed effects regression model:

Y

it

= β

1

X

it

+ α

i

+ u

i

The state averages satisfy:

1

1

T

it

t

Y

T

·

∑

= α

i

+ β

1

1

1

T

it

t

X

T

·

∑

+

1

1

T

it

t

u

T

·

∑

Deviation from state averages:

Y

it

–

1

1

T

it

t

Y

T

·

∑

=

β

1

1

1

T

it it

t

X X

T

·

¸ _

−

¸ ,

∑ +

1

1

T

it it

t

u u

T

·

¸ _

−

¸ ,

∑

8-3

Entity-demeaned OLS regression, ctd.

Y

it

–

1

1

T

it

t

Y

T

·

∑

=

β

1

1

1

T

it it

t

X X

T

·

¸ _

−

¸ ,

∑ +

1

1

T

it it

t

u u

T

·

¸ _

−

¸ ,

∑

or

it

Y

%

= β

1

it

X

%

+

it

u

%

where

it

Y

%

= Y

it

–

1

1

T

it

t

Y

T

·

∑

and

it

X

%

= X

it

–

1

1

T

it

t

X

T

·

∑

• For i=1 and t = 1982,

it

Y

%

is the difference

between the fatality rate in Alabama in 1982,

and its average value in Alabama averaged over

all 7 years.

8-4

Entity-demeaned OLS regression, ctd.

it

Y

%

= β

1

it

X

%

+

it

u

%

(2)

where

it

Y

%

= Y

it

–

1

1

T

it

t

Y

T

·

∑

, etc.

• First construct the demeaned variables

it

Y

%

and

it

X

%

• Then estimate (2) by regressing

it

Y

%

on

it

X

%

using

OLS

• Inference (hypothesis tests, confidence intervals)

is as usual (using heteroskedasticity-robust

standard errors)

• This is like the “changes” approach, but instead

Y

it

is deviated from the state average instead of

Y

i1

.

8-5

Example, ctd.

For n = 48, T = 7:

FatalityRate = –.66BeerTax + State fixed

effects

(.20)

• Should you report the intercept?

• How many binary regressors would you include

to estimate this using the “binary regressor”

method?

• Compare slope, standard error to the estimate for

the 1988 v. 1982 “changes” specification

T = 2, n = 48):

FR

1988

-FR

1982

= –.072 – 1.04(BeerTax

1988

–BeerTax

1982

)

8-6

(.065) (.36)

Regression with Time Fixed Effects

(SW Section 8.4)

An omitted variable might vary over time but not

across states:

• Safer cars (air bags, etc.); changes in national

laws

• These produce intercepts that change over time

• Let these changes (“safer cars”) be denoted by

the variable S

t

, which changes over time but not

states.

• The resulting population regression model is:

Y

it

= β

0

+ β

1

X

it

+ β

2

Z

i

+ β

3

S

t

+ u

it

8-7

Time fixed effects only

Y

it

= β

0

+ β

1

X

it

+ β

3

S

t

+ u

it

In effect, the intercept varies from one year to the

next:

Y

i,1982

= β

0

+ β

1

X

i,1982

+ β

3

S

1982

+ u

i,1982

= (β

0

+ β

3

S

1982

) + β

1

X

i,1982

+ u

i,1982

or

Y

i,1982

= µ

1982

+ β

1

X

i,1982

+ u

i,1982

,

µ

1982

= β

0

+ β

3

S

1982

Similarly,

Y

i,1983

= µ

1983

+ β

1

X

i,1983

+ u

i,1983

,

µ

1983

= β

0

+ β

3

S

1983

etc.

8-8

Two formulations for time fixed effects

1. “Binary regressor” formulation:

Y

it

= β

0

+ β

1

X

it

+ δ

2

B2

t

+ … δ

T

BT

t

+ u

it

where B2

t

=

1 when =2 (year #2)

0 otherwise

t

¹

'

¹

, etc.

2. “Time effects” formulation:

Y

it

= β

1

X

it

+ µ

t

+ u

it

8-9

Time fixed effects: estimation methods

1. “T-1 binary regressors” OLS regression

Y

it

= β

0

+ β

1

X

it

+ δ

2

B2

it

+ … δ

T

BT

it

+ u

it

• Create binary variables B2,…,BT

• B2 = 1 if t = year #2, = 0 otherwise

• Regress Y on X, B2,…,BT using OLS

• Where’s B1?

2. “Year-demeaned” OLS regression

• Deviate Y

it

, X

it

from year (not state) averages

• Estimate by OLS using “year-demeaned”

data

8-10

State and Time Fixed Effects

Y

it

= β

0

+ β

1

X

it

+ β

2

Z

i

+ β

3

S

t

+ u

it

1. “Binary regressor” formulation:

Y

it

= β

0

+ β

1

X

it

+ γ

2

D2

i

+ … + γ

n

Dn

i

+ δ

2

B2

t

+ … δ

T

BT

t

+ u

it

2. “State and time effects” formulation:

Y

it

= β

1

X

it

+ α

i

+ µ

t

+ u

it

8-11

State and time effects: estimation methods

1. “n-1 and T-1 binary regressors” OLS regression

• Create binary variables D2,…,Dn

• Create binary variables B2,…,BT

• Regress Y on X, D2,…,Dn, B2,…,BT using

OLS

• What about D1 and B1?

2. “State- and year-demeaned” OLS regression

• Deviate Y

it

, X

it

from year and state averages

• Estimate by OLS using “year- and state-

demeaned” data

These two methods can be combined too.

. ge

Some Theory: The Fixed Effects Regression

Assumptions (SW App. 8.2)

8-12

For a single X:

Y

it

= β

1

X

it

+ α

i

+ u

it

, i = 1,…,n, t = 1,…, T

1. E(u

it

|X

i1

,…,X

iT

,α

i

) = 0.

2. (X

i1

,…,X

iT

,Y

i1

,…,Y

iT

), i =1,…,n, are i.i.d. draws

from their joint distribution.

3. (X

it

, u

it

) have finite fourth moments.

4. There is no perfect multicollinearity (multiple

X’s)

5. corr(u

it

,u

is

|X

it

,X

is

,α

i

) = 0 for t ≠ s.

Assumptions 3&4 are identical; 1, 2, differ; 5 is

new

Assumption #1: E(u

it

|X

i1

,…,X

iT

,α

i

) = 0

8-13

• u

it

has mean zero, given the state fixed effect

and the entire history of the X’s for that state

• This is an extension of the previous multiple

regression Assumption #1

• This means there are no omitted lagged effects

(any lagged effects of X must enter explicitly)

• Also, there is not feedback from u to future X:

o Whether a state has a particularly high

fatality rate this year doesn’t subsequently

affect whether it increases the beer tax.

o We’ll return to this when we take up time

series data.

8-14

Assumption #2: (X

i1

,…,X

iT

,Y

i1

,…,Y

iT

), i =1,…,n,

are i.i.d. draws from their joint distribution.

• This is an extension of Assumption #2 for

multiple regression with cross-section data

• This is satisfied if entities (states, individuals)

are randomly sampled from their population by

simple random sampling, then data for those

entities are collected over time.

• This does not require observations to be i.i.d.

over time for the same entity – that would be

unrealistic (whether a state has a mandatory

DWI sentencing law this year is strongly related

to whether it will have that law next year).

8-15

Assumption #5: corr(u

it

,u

is

|X

it

,X

is

,α

i

) = 0 for t ≠ s

• This is new.

• This says that (given X), the error terms are

uncorrelated over time within a state.

• For example, u

CA,1982

and u

CA,1983

are uncorrelated

• Is this plausible? What enters the error term?

oEspecially snowy winter

oOpening major new divided highway

oFluctuations in traffic density from local

economic conditions

• Assumption #5 requires these omitted factors

entering u

it

to be uncorrelated over time, within a

state.

8-16

What if Assumption #5 fails:

corr(u

it

,u

is

|X

it

,X

is

,α

i

) ≠0?

• A useful analogy is heteroskedasticity.

• OLS panel data estimators of β

1

are unbiased,

consistent

• The OLS standard errors will be wrong – usually

the OLS standard errors understate the true

uncertainty

• Intuition: if u

it

is correlated over time, you don’t

have as much information (as much random

variation) as you would were u

it

uncorrelated.

• This problem is solved by using

“heteroskedasticity and autocorrelation-consistent

standard errors” – we return to this when we focus

on time series regression

8-17

Application: Drunk Driving Laws and Traffic

Deaths

(SW Section 8.5)

Some facts

• Approx. 40,000 traffic fatalities annually in the

U.S.

• 1/3 of traffic fatalities involve a drinking driver

• 25% of drivers on the road between 1am and

3am have been drinking (estimate)

• A drunk driver is 13 times as likely to cause a

fatal crash as a non-drinking driver (estimate)

8-18

Drunk driving laws and traffic deaths, ctd.

Public policy issues

• Drunk driving causes massive externalities

(sober drivers are killed, etc. etc.) – there is

ample justification for governmental

intervention

• Are there any effective ways to reduce drunk

driving? If so, what?

• What are effects of specific laws:

omandatory punishment

ominimum legal drinking age

oeconomic interventions (alcohol taxes)

8-19

The drunk driving panel data set

n = 48 U.S. states, T = 7 years (1982,…,1988)

(balanced)

Variables

• Traffic fatality rate (deaths per 10,000

residents)

• Tax on a case of beer (Beertax)

• Minimum legal drinking age

• Minimum sentencing laws for first DWI

violation:

o Mandatory Jail

o Manditory Community Service

ootherwise, sentence will just be a monetary

fine

8-20

• Vehicle miles per driver (US DOT)

• State economic data (real per capita income,

etc.)

8-21

Why might panel data help?

• Potential OV bias from variables that vary across

states but are constant over time:

oculture of drinking and driving

oquality of roads

ovintage of autos on the road

Use state fixed effects

• Potential OV bias from variables that vary over

time but are constant across states:

oimprovements in auto safety over time

ochanging national attitudes towards drunk

driving

Use time fixed effects

8-22

8-23

8-24

Empirical Analysis: Main Results

• Sign of beer tax coefficient changes when fixed

state effects are included

• Fixed time effects are statistically significant but

do not have big impact on the estimated

coefficients

• Estimated effect of beer tax drops when other laws

are included as regressor

• The only policy variable that seems to have an

impact is the tax on beer – not minimum drinking

age, not mandatory sentencing, etc.

• The other economic variables have plausibly large

coefficients: more income, more driving, more

deaths

8-25

Extensions of the “n-1 binary regressor”

approach

The idea of using many binary indicators to

eliminate omitted variable bias can be extended to

non-panel data – the key is that the omitted variable

is constant for a group of observations, so that in

effect it means that each group has its own

intercept.

Example: Class size problem.

Suppose funding and curricular issues are

determined at the county level, and each county

has several districts. Resulting omitted variable

bias could be addressed by including binary

indicators, one for each county (omit one to

avoid perfect multicollinearity).

8-26

Summary: Regression with Panel Data

(SW Section 8.6)

Advantages and limitations of fixed effects

regression

Advantages

• You can control for unobserved variables that:

ovary across states but not over time, and/or

ovary over time but not across states

• More observations give you more information

• Estimation involves relatively

straightforward extensions of multiple regression

8-27

• Fixed effects estimation can be done three

ways:

1. “Changes” method when T = 2

2. “n-1 binary regressors” method when n is

small

3. “Entity-demeaned” regression

• Similar methods apply to regression with

time fixed effects and to both time and state

fixed effects

• Statistical inference: like multiple regression.

Limitations/challenges

• Need variation in X over time within states

• Time lag effects can be important

8-28

• Standard errors might be too low (errors might

be correlated over time)

8-29

**1. “n-1 binary regressors” OLS regression Yit = β0 + β1Xit + γ 2D2i + … + γ nDni + ui where
**

1 for i =2 (state #2) D2i = 0 otherwise

(1)

etc.

•

First create the binary variables D2i,…,Dni

• Then estimate (1) by OLS • Inference (hypothesis tests, confidence intervals) is as usual (using heteroskedasticity-robust standard errors) • This is impractical when n is very large (for example if n = 1000 workers)

8-2

2. “Entity-demeaned” OLS regression The fixed effects regression model: Yit = β1Xit + αi + ui The state averages satisfy: 1 T 1 T 1 T ∑Yit = αi + β1 T ∑ X it + T ∑ uit T t =1 t =1 t =1 Deviation from state averages: 1 T Yit – ∑Yit = T t =1 1 T 1 T β1 X it − ∑ X it + uit − ∑ uit T t =1 T t =1 8-3 .

1 T Yit – ∑Yit = T t =1 1 T 1 T β1 X it − ∑ X it + uit − ∑ uit T t =1 T t =1 or % % % Yit = β1 X it + uit 1 T 1 T % % where Yit = Yit – ∑Yit and X it = Xit – ∑ X it T t =1 T t =1 • % For i=1 and t = 1982.Entity-demeaned OLS regression. and its average value in Alabama averaged over all 7 years. 8-4 . Yit is the difference between the fatality rate in Alabama in 1982. ctd.

8-5 . % % % Yit = β1 X it + uit 1 T % where Yit = Yit – ∑Yit . but instead Yit is deviated from the state average instead of Yi1. ctd. T t =1 • • (2) % % First construct the demeaned variables Yit and X it % % Then estimate (2) by regressing Yit on X it using OLS • Inference (hypothesis tests. etc. confidence intervals) is as usual (using heteroskedasticity-robust standard errors) • This is like the “changes” approach.Entity-demeaned OLS regression.

Example. n = 48): FR1988-FR1982 = –.20) • Should you report the intercept? • How many binary regressors would you include to estimate this using the “binary regressor” method? • Compare slope.04(BeerTax1988–BeerTax1982) 8-6 . T = 7: FatalityRate = –. ctd.66BeerTax + State fixed effects (. 1982 “changes” specification T = 2. standard error to the estimate for the 1988 v.072 – 1. For n = 48.

36) Regression with Time Fixed Effects (SW Section 8. which changes over time but not states. • The resulting population regression model is: Yit = β0 + β1Xit + β2Zi + β3St + uit 8-7 . changes in national laws • These produce intercepts that change over time • Let these changes (“safer cars”) be denoted by the variable St.4) An omitted variable might vary over time but not across states: • Safer cars (air bags. etc.065) (.(.).

8-8 .1983 + ui.1982. µ1982 = β0 + β3S1982 Similarly.1982 = µ1982 + β1Xi.1982 = (β0 + β3S1982) + β1Xi.1983 = µ1983 + β1Xi.1982 or Yi.Time fixed effects only Yit = β0 + β1Xit + β3St + uit In effect.1983. the intercept varies from one year to the next: Yi. µ1983 = β0 + β3S1983 etc.1982 + ui. Yi.1982 + ui.1982 = β0 + β1Xi.1982 + β3S1982 + ui.

0 otherwise 2. “Binary regressor” formulation: Yit = β0 + β1Xit + δ 2B2t + … δ TBTt + uit 1 when t =2 (year #2) where B2t = .Two formulations for time fixed effects 1. “Time effects” formulation: Yit = β1Xit + µt + uit 8-9 . etc.

B2. Xit from year (not state) averages • Estimate by OLS using “year-demeaned” data 8-10 .…. “T-1 binary regressors” OLS regression Yit = β0 + β1Xit + δ 2B2it + … δ TBTit + uit • • • • Create binary variables B2.Time fixed effects: estimation methods 1.BT using OLS Where’s B1? 2. “Year-demeaned” OLS regression • Deviate Yit. = 0 otherwise Regress Y on X.BT B2 = 1 if t = year #2.….

“Binary regressor” formulation: Yit = β0 + β1Xit + γ 2D2i + … + γ nDni + δ 2B2t + … δ TBTt + uit 2. “State and time effects” formulation: Yit = β1Xit + αi + µt + uit 8-11 .State and Time Fixed Effects Yit = β0 + β1Xit + β2Zi + β3St + uit 1.

Dn • Create binary variables B2.2) 8-12 . “n-1 and T-1 binary regressors” OLS regression • Create binary variables D2. 8.and year-demeaned” OLS regression • Deviate Yit.BT using OLS • What about D1 and B1? 2.State and time effects: estimation methods 1.Dn.and statedemeaned” data These two methods can be combined too. B2. Some Theory: The Fixed Effects Regression Assumptions (SW App.….….….BT • Regress Y on X.…. “State. D2. Xit from year and state averages • Estimate by OLS using “year.

2.….Xis. draws from their joint distribution.….αi) = 0 for t ≠ s.d.….For a single X: Yit = β1Xit + αi + uit. 5 is new 5. 3.….i. are i. 1. 2. E(uit|Xi1. (Xit.XiT.Yi1.αi) = 0. Assumption #1: E(uit|Xi1.….XiT.n.….YiT). uit) have finite fourth moments. t = 1.XiT. i = 1.αi) = 0 8-13 . i =1. T 1. Assumptions 3&4 are identical. 4.n.uis|Xit. There is no perfect multicollinearity (multiple X’s) corr(uit. (Xi1. differ.….

o We’ll return to this when we take up time series data. given the state fixed effect and the entire history of the X’s for that state This is an extension of the previous multiple regression Assumption #1 This means there are no omitted lagged effects (any lagged effects of X must enter explicitly) Also.• • • • uit has mean zero. 8-14 . there is not feedback from u to future X: o Whether a state has a particularly high fatality rate this year doesn’t subsequently affect whether it increases the beer tax.

individuals) are randomly sampled from their population by simple random sampling.Yi1.…. • This does not require observations to be i.d.n.….i.i. 8-15 . • This is an extension of Assumption #2 for multiple regression with cross-section data • This is satisfied if entities (states.d. are i. over time for the same entity – that would be unrealistic (whether a state has a mandatory DWI sentencing law this year is strongly related to whether it will have that law next year). draws from their joint distribution.XiT.…. i =1.YiT). then data for those entities are collected over time.Assumption #2: (Xi1.

• This says that (given X). uCA.Xis.1983 are uncorrelated • Is this plausible? What enters the error term? oEspecially snowy winter oOpening major new divided highway oFluctuations in traffic density from local • economic conditions Assumption #5 requires these omitted factors entering uit to be uncorrelated over time. within a state.uis|Xit.Assumption #5: corr(uit.αi) = 0 for t ≠ s • This is new. the error terms are uncorrelated over time within a state. 8-16 . • For example.1982 and uCA.

• This problem is solved by using “heteroskedasticity and autocorrelation-consistent standard errors” – we return to this when we focus on time series regression 8-17 .What if Assumption #5 fails: corr(uit. consistent • The OLS standard errors will be wrong – usually the OLS standard errors understate the true uncertainty • Intuition: if uit is correlated over time.αi) ≠0? • A useful analogy is heteroskedasticity.Xis.uis|Xit. you don’t have as much information (as much random variation) as you would were uit uncorrelated. • OLS panel data estimators of β1 are unbiased.

• 1/3 of traffic fatalities involve a drinking driver • 25% of drivers on the road between 1am and 3am have been drinking (estimate) • A drunk driver is 13 times as likely to cause a fatal crash as a non-drinking driver (estimate) 8-18 .5) Some facts • Approx. 40.000 traffic fatalities annually in the U.Application: Drunk Driving Laws and Traffic Deaths (SW Section 8.S.

Public policy issues • Drunk driving causes massive externalities (sober drivers are killed. etc. etc.Drunk driving laws and traffic deaths.) – there is ample justification for governmental intervention • Are there any effective ways to reduce drunk driving? If so. what? • What are effects of specific laws: omandatory punishment ominimum legal drinking age oeconomic interventions (alcohol taxes) 8-19 . ctd.

T = 7 years (1982.…. sentence will just be a monetary fine 8-20 .S.1988) (balanced) Variables • Traffic fatality rate (deaths per 10. states.The drunk driving panel data set n = 48 U.000 residents) • Tax on a case of beer (Beertax) • Minimum legal drinking age • Minimum sentencing laws for first DWI violation: o Mandatory Jail o Manditory Community Service ootherwise.

) 8-21 . etc.• Vehicle miles per driver (US DOT) • State economic data (real per capita income.

Why might panel data help? • Potential OV bias from variables that vary across states but are constant over time: oculture of drinking and driving oquality of roads ovintage of autos on the road Use state fixed effects • Potential OV bias from variables that vary over time but are constant across states: oimprovements in auto safety over time ochanging national attitudes towards drunk driving Use time fixed effects 8-22 .

8-23 .

8-24 .

• The other economic variables have plausibly large coefficients: more income.Empirical Analysis: Main Results • Sign of beer tax coefficient changes when fixed state effects are included • Fixed time effects are statistically significant but do not have big impact on the estimated coefficients • Estimated effect of beer tax drops when other laws are included as regressor • The only policy variable that seems to have an impact is the tax on beer – not minimum drinking age. not mandatory sentencing. more driving. more deaths 8-25 . etc.

and each county has several districts. one for each county (omit one to avoid perfect multicollinearity). Suppose funding and curricular issues are determined at the county level. so that in effect it means that each group has its own intercept. Resulting omitted variable bias could be addressed by including binary indicators. 8-26 .Extensions of the “n-1 binary regressor” approach The idea of using many binary indicators to eliminate omitted variable bias can be extended to non-panel data – the key is that the omitted variable is constant for a group of observations. Example: Class size problem.

6) Advantages and limitations of fixed effects regression Advantages • You can control for unobserved variables that: ovary across states but not over time.Summary: Regression with Panel Data (SW Section 8. and/or ovary over time but not across states • More observations give you more information • Estimation involves relatively straightforward extensions of multiple regression 8-27 .

“Changes” method when T = 2 2. “n-1 binary regressors” method when n is small 3.• Fixed effects estimation can be done three ways: 1. Limitations/challenges • Need variation in X over time within states • Time lag effects can be important 8-28 . “Entity-demeaned” regression • Similar methods apply to regression with time fixed effects and to both time and state fixed effects • Statistical inference: like multiple regression.

• Standard errors might be too low (errors might be correlated over time) 8-29 .

- Assessing the Economic Justification for Government Involvement in Sports
- frm_aim_statements_2013-web.pdf
- R1
- 198
- Collateral-Damage.pdf
- Introduction to Econometrics- Stock & Watson -Ch 5 Slides.doc
- Salavatore+Ch+4.ppt
- Econometrics Chapter 10 PPT slides
- Analysis of International Tourist Arrivals Worldwide
- THE EXPECTED STOCK RETURNS OF MALAYSIAN FIRMS: A PANEL DATA ANALYSIS
- Matrix Diff
- Panel 2(Sata)
- 17668_Chapter2
- 7. Heckman - Correction for Nonrandom Samples Nobel Prize Winning Concept
- Does Teacher Quality Affect Student Performance Evidence From an Italian University
- Functional Form 2 Up
- rev_lect_3&4_J
- Board Size, Composition and the Performance of Private Sector Banks-2
- Lesson 2 - Main Estimation Methods for Panel Data-PTBNgoc
- reformservice_bp5
- SSRN-id1007905
- Perceptual Mapping
- ForecastForecasting with term structure
- Wage inequality on the rise: Uruguay 1986 – 2007 The role of workers’ characteristics
- Modeling Sustainable Earnings and PE Ratios with FSA
- Lecture 4.2 4on1
- Productivity
- Alston et al
- Wall Ent in 2016
- MPRA Paper 15021

Sign up to vote on this title

UsefulNot usefulRead Free for 30 Days

Cancel anytime.

Close Dialog## Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

Loading