Common Correlated Effects Estimation of Dynamic Panels with Cross-Sectional Dependence

Gerdie Everaert · Tom De Groote

114 citations0/0 files storedEconometric Reviews

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Spatial and Panel Data Analysis Economic Growth and Productivity Statistical Methods and Bayesian Inference

Abstract

We derive inconsistency expressions for dynamic panel data estimators under error cross-sectional dependence generated by an unobserved common factor in both the fixed effect and the incidental trends case. We show that for a temporally dependent factor, the standard within groups (WG) estimator is inconsistent even as both N and T tend to infinity. Next we investigate the properties of the common correlated effects pooled (CCEP) estimator of Pesaran (2006) which eliminates the error cross-sectional dependence using cross-sectional averages of the data. In contrast to the static case, the CCEP estimator is only consistent when next to N also T tends to infinity. It is shown that for the most relevant parameter settings, the inconsistency of the CCEP estimator is larger than that of the infeasible WG estimator, which includes the common factors as regressors. Restricting the CCEP estimator results in a somewhat smaller inconsistency. The small sample properties of the various estimators are analyzed using Monte Carlo experiments. The simulation results suggest that the CCEP estimator can be used to estimate dynamic panel data models provided T is not too small. The size of N is of less importance.

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References

1991Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations 1998Initial conditions and moment restrictions in dynamic panel data models 1995Initial conditions and moment restrictions in dynamic panel data models 2007A simple panel unit root test in the presence of cross‐section dependence 1981Biases in Dynamic Models with Fixed Effects 2006Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure 2002Determining the Number of Factors in Approximate Factor Models 1995On bias, inconsistency, and efficiency of various estimators in dynamic panel data models

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