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Applied Econometrics:
Panel Lecture
Chapter 16, Gujarati
In Panel Data, the Same Cross-
sectional Unit Is Surveyed Over
Time.
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Introduction
Today we will examine panel
econometrics.
One of the biggest areas of modern
econometrics.
See Gujarati for introduction.
More advanced panel textbooks
outside the scope of our discussion.
Today we will introduce these topics
and look at some empirical
examples.
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Topics of Discussion
Types of data cross sectional/time
series/panel.
Reexaming economic models.
Types of panel.
Example of panel.
Estimating panel models.
Fixed effects versus random effects.
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Main Point of Lecture
Panel econometrics is a huge field
and to cover everything would not
be possible. This lecture aims to
introduce you to panel econometrics
using research examples.
Particularly, I want to discuss when
and why you would use fixed versus
random effects models.
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Terminology
Time series cross section data/
micropanel data/longitudanal
data/cohort analysis/ event history
analysis.
Many authors use the above terms
interchangeably. Will talk about
some potential distinctions.
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Why Panel Data?
Allows one to analyse issues such as
persistency (e.g. Unemployment).
Allows one to examine complex
behavioural models (e.g. Life cycle models
of saving/consumption).
Allows one to explicitly take in to account
individual heterogeneity.

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Limitations of Panel Data
(i) Measurement Error that can arise in survey
data

(ii) Self-Selection in to the panel

(iii) Non-Response

(iv) Attrition

(v) Typically, micro-panels cover a short time
dimension e.g. the Living in Ireland covers only
from 1994 to 2001.

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Some Examples of Panel
Labour economics, welfare economics and
several other fields rely heavily on household
panel studies.
Panel study of income dynamics (Michigan).
Industrial economics utilises very large panel
datasets (e.g. Amadeus).
In Ireland, the ESRI ran the living in Ireland
survey panel from 1994 to 2001 (will
examine some of this later in the class).
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Famous Panel Studies
Canadian Survey of Labour Income
Dynamics
Japanese Panel on Consumers
Korea Labor and Income Panel Surveys
Household Income and Labor Dynamics
in Australia
Indonesia Family Life Surveys

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Economic Modelling
Very similar principles of economic
modelling apply to panel as applied
to the other techniques we have
examined.
Specification issues e.g. Omitted
variables or irrelevant included
variables.
Distributional issues e.g. Non-
normality.
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An Example of a Panel Model (1)
Grunfelds (1958) investment data.
A little dated but will help us to
work through the stuff in gujarati.
Q: how does investment depend on
the real value of the firm and the
real capital stock?
Data: 4 companies for 20 years
(from 1935 1954).
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5 Ways of Estimating a Panel
Model
Assume that intercepts and slopes are
the same over time and individuals.
Assume that slopes are constant but
that intercepts vary over individuals.
Assume that slopes are constant but
that intercepts vary over time and
individuals.
Assume that all coefficients vary over
individuals.
Assume that all coefficients vary over
individuals and time.

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reg grossinv valuefirm capstock

Source | SS df MS Number of obs = 80
-------------+------------------------------ F( 2, 77) = 119.63
Model | 4849457.37 2 2424728.69 Prob > F = 0.0000
Residual | 1560689.67 77 20268.697 R-squared = 0.7565
-------------+------------------------------ Adj R-squared = 0.7502
Total | 6410147.04 79 81141.1018 Root MSE = 142.37

------------------------------------------------------------------------------
grossinv | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
valuefirm | .1100955 .0137297 8.02 0.000 .0827563 .1374348
capstock | .3033932 .0492957 6.15 0.000 .2052328 .4015535
_cons | -63.30413 29.6142 -2.14 0.036 -122.2735 -4.334735
------------------------------------------------------------------------------

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. xtreg grossinv valuefirm capstock, fe
Fixed-effects (within) regression Number of obs = 80
Group variable (i): nofirm Number of groups = 4
R-sq: within = 0.8068 Obs per group: min = 20
between = 0.7304 avg = 20.0
overall = 0.7554 max = 20
F(2,74) = 154.53
corr(u_i, Xb) = -0.1001 Prob > F = 0.0000
grossinv | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
valuefirm | .1079481 .0175089 6.17 0.000 .0730608 .1428354
capstock | .3461617 .0266645 12.98 0.000 .2930315 .3992918
_cons | -73.84946 37.52291 -1.97 0.053 -148.6155 .9165748
-------------+----------------------------------------------------------------
sigma_u | 139.05116
sigma_e | 75.288894
rho | .77329633 (fraction of variance due to u_i)
------------------------------------------------------------------------------
F test that all u_i=0: F(3, 74) = 67.11 Prob > F = 0.0000

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. xtreg grossinv valuefirm capstock, re
Random-effects GLS regression Number of obs = 80
Group variable (i): nofirm Number of groups = 4

R-sq: within = 0.8068 Obs per group: min = 20
between = 0.7303 avg = 20.0
overall = 0.7554 max = 20
Random effects u_i ~ Gaussian Wald chi2(2) = 317.79
corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000
------------------------------------------------------------------------------
grossinv | Coef. Std. Err. z P>|z| [95% Conf. Interval]
-------------+----------------------------------------------------------------
valuefirm | .1076555 .0168169 6.40 0.000 .0746949 .140616
capstock | .3457104 .0265451 13.02 0.000 .2936829 .3977378
_cons | -73.03529 83.94957 -0.87 0.384 -237.5734 91.50284
-------------+----------------------------------------------------------------
sigma_u | 152.15823
sigma_e | 75.288894
rho | .80332024 (fraction of variance due to u_i)

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Fixed Effect Panel Model
The intercept in the regression is
allowed to differ among individuals
in recognition of the fact that each
individual (unit) may have
characteristics of their own.
Also known as the least squares
dummy variable model.
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Why use Fixed Effects
Fixed Effects are generally used
when there is a correlation between
the individual intercept and the
independent variables.
Generally used when n is relatively
small and t is relatively large.

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Random Effects Model
Random Effects models assume
that the intercept of an individual
unit is a random drawing from a
much larger population with a
constant mean value.
Also (less frequently) know as the
Error Components model.
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Fixed Effects or Random Effects
IF N is large and T is small, and if the
assumptions underlying RE hold, the RE
are more efficient estimators.
Use Fixed Effects if the errors and the
observations are correlated (e.g.
countries).
The Hausman test is distributed Chi-
Squared Asymptotic around the null
hypothesis that Random Effects is
appropriate.
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Hausman Test
Hausman (1978).
The null hypothesis is that the FE and RE
do not differ substantially.
Test is distributed asymptotically chi-
squared.
FE is consistent under both the null and
the alternative.
RE is consistent under the null and
inconsistent under the alternative.
We can test the appropriateness of RE
using critical values.
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. hausman fixed

---- Coefficients ----
| (b) (B) (b-B) sqrt(diag(V_b-V_B))
| fixed . Difference S.E.
-------------+----------------------------------------------------------------
valuefirm | .1079481 .1076555 .0002926 .0048738
capstock | .3461617 .3457104 .0004513 .0025204
------------------------------------------------------------------------------
b = consistent under Ho and Ha; obtained from xtreg
B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(2) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 0.07
Prob>chi2 = 0.9678

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An Example of a Panel Model (2)
Did people get better off over the
course of the Celtic tiger?
We certainly became richer but how
about happier or more satisfied with
our income?
To address this question I have been
analysing a panel of people tracked
from 1994 to 2001.
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An Example of a Panel Model (3)
What are the determinants of international disputes.
Beck et. al. (1998) in their paper on international
conflict, and consist of time-varying data on 827
politically-relevant dyads in the international
system. Each dyad has one observation for each year
from 19501985, inclusive. Omitting observations
with ongoing conflicts, this yields a total N = 20448.
This data is taken from Chris Zorns Easter
Workshop on Panel Econometrics at Oxford.
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Dyadid: The dyad identification number.
Year: The year identifier.
Dispute: 1 if a militarized interstate dispute occurred between
the members of that dyad in that year, 0 otherwise.
Start: The starting counter variable.
Duration: The duration variable.
Democ: Rescaled POLITY democracy variable ( [-1,1]).
Growth: Lagged measure of growth, as a proportion of GDP.
Allies: 1 if the dyad members are allied, 0 otherwise.
contig : 1if the members of the dyad are geographically
contiguous, 0 otherwise.
Capratio: The natural log of the ratio of the two states military
capacities, as measured by the
Correlates of War (COW) data.
Trade: The ratio of bilateral trade to GDP, in constant US
dollars.
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Outside the Scope (1)
Generalised Panels can utilise many different
distributional forms with many different types of
data.
Quasi-Maximum Likelihood Techniques that
make less assumptions about the full distribution
have become increasingly utilised.
STATA package of choice for most researchers
but other packages such as LIMDEP and R have
become increasingly used.
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Outside the Scope (2)
A great deal of work has been
conducted on what to do with the
problem of unbalanced panel data.
Sample selection models to deal
with panel attrition have also
become increasingly important in
the literature.