Econometric Analysis of Panel

Data

SUMMARY
Pooled Regression

 Presence of omitted effects

y it =x itβ+c i +εit , observation for person i at time t

y i =X iβ+c ii+ε i , Ti observations in group i
=X iβ+c i +ε i , note c i  (c i , c i ,...,c i )
y =Xβ+c +ε , Ni=1 Ti observations in the sample
Pooled Regression: Estimation -1
 If it is assumed that is well behaved

if
 OLS is a BLUE estimator
b=(X X )-1 X'y

With estimated variance in which

Where
Pooled Regression: Estimation -2

 If Possible Heteroecedasticity
 We have to find a “robust” covariance matrix
 A robust estimation (in general) is the White estimator (Chap-2 slide 8)
 Bootstrapping (another approach)
Method:
1. Estimate using full sample: --> b
2. Repeat R times:
Draw n observations from the n, with replacement
Estimate  with b(r).
3. Estimate variance with
W = (1/R)r [b(r) - ][b(r) - ]’
Pooled Regression: Estimation -3

 Using first differences

 , observation for personat time
 Eliminating the heterogeneity

y it = y it - y i,t-1 = (xit )β+c i + εit

= (xit )β + uit

Note: Time invariant variables become zero

Time trend becomes a constant term
Fixed effect model

The fixed effects model

y it =x itβ+c i +ε it , observation for person i at time t
y i =X iβ+c ii+ε i , Ti observations in group i
=X iβ+ci +ε i , note c i  (c i , c i ,...,c i )
y =Xβ+c +ε, Ni=1 Ti observations in the sample
c=(c1 , c2 ,...cN ), Ni=1 Ti by 1 vector
ci is arbitrarily correlated with xit but E[εit|Xi,ci]=0
Dummy variable representation
y it =x itβ+Nj=1 j dijt +εit , dijt = 1(i=j)
 Useful Analysis of Variance Notation

Decomposition of Total variation:

2
N
Σ Σ Ti 2
(zit  z)  Σ N
Σ Ti
(zit  zi .)   Σ Ti  zi .  z 
2 N
i=1 t=1 i=1  t=1 i=1

Total variation = Within groups variance + Between groups variance

Fixed effect model – Matrix Form

yi = Xi + dici + εi, for each individual

 y1   X1 d1 0 0 0
  X
 y2    2 0 d2 0 0   β 
  ε
          α
   
 yN   X N 0 0 0 dN 
β
= [X, D]    ε
 α
= Zδ  ε
E[ci | Xi ] = g(Xi); Effects are correlated with included variables.
Cov[xit,ci] ≠0
Fixed effect model – Matrix Form

 X1 d1 0 0  (T1 rows)
X 0 d2 0  (T2 rows)
 2 
X D   X 3 0 0 d3  (T3 rows)
 
     0 
 X N 0 0 0 dN  (TN rows)

 X i1 i2  iN   N
T rows 
i=1 i
Estimating the Fixed Effects Model

 The FEM is a simple linear regression model but with many independent variables
 Least squares estimator of  is unbiased, consistent, efficient, but inconvenient if N is
large.

1
b  X X X D   X y 
  DX DD  Dy 
 a    
Using the Frisch-Waugh theorem
b =[X MD X ]1 X MD y 
 Estimating the Fixed Effects Model

M1D 0 0 
 2 
0 MD 0 
MD   (The dummy variables are orthogonal)
 
 N

 0 0 MD 
MDi  I Ti  di (didi ) 1 di = I Ti  (1/Ti )didi

X MD X = Ni=1 X iMDi X i ,  

X iMDi X i
k,l
T
  t=1
i
(x it,k -x i.,k )(x it,l -x i.,l )

X MD y = Ni=1 X iMDi y i , XM y 

i
i
D i k
i
T
  t=1 (x it,k -x i.,k )(y it -y i. )

If all groups have the same Ti , MD  M0  I where M0  I T  (1/T)dd

 
1
X MD X = X [M  I]X and b = X [M  I]X
0 0
X [M0  I]y.
Least Squares Dummy Variable Estimator
(LSDV)
 b is obtained by ‘within’ groups least squares (group mean deviations)
 Normal equations for a are D’Xb+D’Da=D’y
a = (D’D)-1D’(y – Xb)

Ti
ai =(1/Ti )Σ t=1 (y it -x it b)=ei

Notes: This is simple algebra – the estimator is just OLS

Least squares is an estimator, not a model. (Repeat twice.)
Note what ai is when Ti = 1. Follow this with yit-ai-xit’b=0 if Ti=1.