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Fabian Waldinger
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Topics Covered in Lecture
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Panel Data
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Panel Data - Some Denitions
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The Omitted Variables Problem
E (y j x, c ) = 0 + x+ c
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The Omitted Variables Problem - Cross-Sectional Data
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Strict Exogeneity Assumption
To estimate the most basic panel data models (random eects
estimator and xed eects estimator) we assume strict exogoneity :
E (yit j xi 1 , xi 2 , ..., xiT , ci ) = E (yit jxit , ci ) = xit + ci
In words: once xit and ci are controlled for, xis has no partial eect
on yit for s 6= t.
In the regression model yit = xit + ci + uit the strict exogeneity
assumption can be stated in terms of idiosyncratic errors as:
E (uit j xi 1 , xi 2 , ..., xiT , ci ) = 0, t = 1, 2, ..., T
Random eects models eectively put ci in the error term under the
assumption that ci is orthogonal to xit and then accounts for the
serial correlation in the composite error.
Random eects models therefore impose strict exogeneity plus
orthogonality between ci and xit :
1 - E (uit j xi , ci ) = 0, t = 1, 2, ..., T
- E (ci j xi ) = E (ci ) = 0
where xi = (xi 1 , xi 2 , ..., xiT )
The important part of assumption 2 is E (ci j xi ) = E (ci ) the
assumption E (ci ) = 0 is without loss of generality as long as an
intercept is included in xit .
With the second part of this assumption even OLS would be
consistent but not e cient ) use GLS.
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Random Eects = Feasible GLS
The random eects approach accounts for the serial correlation in the
composite error it = ci + uit .
Rewriting our regression model including the composite error:
yit = xit + it
E (it j xi ) = 0 t = 1, 2, ..., T
We can therefore apply GLS methods that account for the particular
error structure in it = ci + uit .
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Random Eects = Feasible GLS
yi = Xi + vi
E (vi vi0 )
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Random Eects = Feasible GLS
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Random Eects = Feasible GLS
b
b2u IT +
b2c jT jT0
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Fixed Eects
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Fixed Eects - 3 Ways to Eliminate c
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1. Within Estimator
Estimating equation:
y i = xi + ci + u i (2)
T T T
1 1 1
Where: yi = T yit , xi = T xit , ui = T uit
t =1 t =1 t =1
Step 2: Substract equation (2) from equation (1) to get:
yeit = yit y i ,
Where: e
xit = (xit xi ), eit = uit u i
u
Step 3: Run a regression of yeit on e
xit using pooled OLS.
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1. Within Estimator
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1. Within Estimator Standard Errors
The standard errors from a standard OLS regression estimated under
Step 3 above would not be correct. Why?
Demeaning introduces serial correlation of the error terms:
eit :
Variance of u
eit ) = E [(uit
E (u u i )2 ] = E (uit2 ) + E (u 2i ) 2E (uit u i )
= 2u + 2u /T 22u /T = 2u (1 1/T )
eit and u
Covariance between u eis for t 6= s :
eit u
E (u eis ) = E [(uit u i )(uis u i )]
= E (uit uis ) E (uit u i ) E (uis u i ) + E (u 2i )
=0 2u /T 2u /T + 2u /T = 2u /T
eit and u
As a result the correlation between u eis is:
Cov (ueit ,e
u is ) 2u /T 1
uis ) = p
eit ,e
Corr (u = 2u (1 1/T )
= (T 1 )
Var (ueit )Var (ueis )
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1. Within Estimator Standard Errors
Assumption 3 allows us to derive an estimand of the asymptotic
variance:
N T
ar ( b
Avb b2u ( e
FE ) = xit0 e
xit ) 1
i =1 i =1
SSR/(N (T 1) K)
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2. Dummy Variables Estimator
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3. First Dierencing
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3. First Dierencing
yit on xit
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3. First Dierencing - Standard Errors
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Practical Tips: RE versus FE, FD, or Dummy Variables
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Introductory Example on the Use of Fixed Eects - The
Eect of Unionization on Wages
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Estimation of Fixed Eects Models
Suppose you simply estimate this model with OLS (without including
individual xed eects).
You therefore estimate:
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The Eect of Unionization on Wages - OLS vs. FE
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Measurement Error and Fixed Eects Models
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Example Measurement Error
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Estimating and Analyzing Fixed Eects - Bertrand and
Schoar (2003)
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Bertrand and Schoar (2003) - Regression of Interest
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Manager Transitions Across Firms
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Bertrand and Schoar (2003) - How Do Manager FE Aect
R-Square?
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Bertrand and Schoar (2003) - How Do Manager FE Aect
R-Square?
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Bertrand and Schoar (2003) - How Do Manager FE Aect
R-Square?
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Bertrand and Schoar (2003) - Using Manager FEs to
Understand "Managing Styles"
FE (yj ) = + FE (zj ) + ej
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Bertrand and Schoar (2003) - Using Manager FEs to
Understand "Managing Styles"
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Bertrand and Schoar (2003) - Are Manager FEs Correlated
with Compensation?
They then investigate whether the dierent FEs are correlated with
compensation.
Row (1): managers who have positive FEs for returns on assets also
receive higher compensation.
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Card, Heining, and Kline (2013) - Use Firm and Worker FE
to Decompose Changes in German Wage-Inequality
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Card, Heining, and Kline (2013) - Empirical Specication
They estimate the following wage equation with establishment (J )
and worker xed eects (i ):
yit = i + J + xit0 + rir
Where the error term has a RE structure that allows for the
correlation of errors within a worker-establishment pair.
In matrix notation the model can be written as:
y = D + F + X + r = Z 0 + r
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Card, Heining, and Kline (2013) - Variance Decompositions
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Card, Heining, and Kline (2013) - Variance
Decompositions - Results
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Card, Heining, and Kline (2013) - Variance Decompositions
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Card, Heining, and Kline (2013) - Graphical Evidence for
Increase Assortative Matching - First Period
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Card, Heining, and Kline (2013) - Graphical Evidence for
Increase Assortative Matching - Last Period
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