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On the role of the rank condition in CCE estimation of factor-augmented panel regressions

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  • Karabiyik, Hande
  • Reese, Simon
  • Westerlund, Joakim

Abstract

A popular approach to factor-augmented panel regressions is the common correlated effects (CCE) estimator of Pesaran (2006). This paper points to a problem with the CCE approach that appears in the empirically relevant case when the number of factors is strictly less than the number of observables used in their estimation. Specifically, the use of too many observables causes the second moment matrix of the estimated factors to become asymptotically singular, an issue that has not yet been appropriately accounted for. The purpose of the present paper is to fill this gap in the literature.

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  • Karabiyik, Hande & Reese, Simon & Westerlund, Joakim, 2017. "On the role of the rank condition in CCE estimation of factor-augmented panel regressions," Journal of Econometrics, Elsevier, vol. 197(1), pages 60-64.
    • Handle: RePEc:eee:econom:v:197:y:2017:i:1:p:60-64
    DOI: 10.1016/j.jeconom.2016.10.006
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    3. Pesaran, M. Hashem & Vanessa Smith, L. & Yamagata, Takashi, 2013. "Panel unit root tests in the presence of a multifactor error structure," Journal of Econometrics, Elsevier, vol. 175(2), pages 94-115.
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    5. M. Hashem Pesaran, 2006. "Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure," Econometrica, Econometric Society, vol. 74(4), pages 967-1012, July.
    6. Chang, Yoosoon & Phillips, Peter C.B., 1995. "Time Series Regression with Mixtures of Integrated Processes," Econometric Theory, Cambridge University Press, vol. 11(5), pages 1033-1094, October.
    7. Westerlund, Joakim & Urbain, Jean-Pierre, 2015. "Cross-sectional averages versus principal components," Journal of Econometrics, Elsevier, vol. 185(2), pages 372-377.
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    Cited by:

    1. Akgun, Oguzhan & Pirotte, Alain & Urga, Giovanni, 2020. "Forecasting using heterogeneous panels with cross-sectional dependence," International Journal of Forecasting, Elsevier, vol. 36(4), pages 1211-1227.
    2. Artūras Juodis, 2022. "A regularization approach to common correlated effects estimation," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 37(4), pages 788-810, June.
    3. Westerlund, Joakim & Petrova, Yana, 2018. "Asymptotic collinearity in CCE estimation of interactive effects models," Economic Modelling, Elsevier, vol. 70(C), pages 331-337.
    4. Westerlund, Joakim & Sharma, Susan Sunila, 2019. "Panel evidence on the ability of oil returns to predict stock returns in the G7 area," Energy Economics, Elsevier, vol. 77(C), pages 3-12.
    5. Norkutė, Milda & Westerlund, Joakim, 2021. "The factor analytical approach in near unit root interactive effects panels," Journal of Econometrics, Elsevier, vol. 221(2), pages 569-590.
    6. In Choi & Rui Lin & Yongcheol Shin, 2020. "Online Appendix for Canonical Correlation-based Model Selection for the Multilevel Factors," Working Papers 2008, Nam Duck-Woo Economic Research Institute, Sogang University (Former Research Institute for Market Economy).
    7. Jan Ditzen, 2021. "Estimating long-run effects and the exponent of cross-sectional dependence: An update to xtdcce2," Stata Journal, StataCorp LP, vol. 21(3), pages 687-707, September.
    8. George Kapetanios & Laura Serlenga & Yongcheol Shin, 2023. "Testing for correlation between the regressors and factor loadings in heterogeneous panels with interactive effects," Empirical Economics, Springer, vol. 64(6), pages 2611-2659, June.
    9. Yiannis Karavias & Paresh Kumar Narayan & Joakim Westerlund, 2023. "Structural Breaks in Interactive Effects Panels and the Stock Market Reaction to COVID-19," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 41(3), pages 653-666, July.
    10. Choi, In & Lin, Rui & Shin, Yongcheol, 2023. "Canonical correlation-based model selection for the multilevel factors," Journal of Econometrics, Elsevier, vol. 233(1), pages 22-44.
    11. Nicholas L. Brown & Peter Schmidt & Jeffrey M. Wooldridge, 2021. "Simple Alternatives to the Common Correlated Effects Model," Papers 2112.01486, arXiv.org.
    12. Hande Karabiyik & Joakim Westerlund, 2021. "Forecasting using cross-section average–augmented time series regressions," The Econometrics Journal, Royal Economic Society, vol. 24(2), pages 315-333.
    13. De Vos, Ignace & Everaert, Gerdie & Sarafidis, Vasilis, 2021. "A method for evaluating the rank condition for CCE estimators," MPRA Paper 112305, University Library of Munich, Germany, revised 09 Mar 2022.
    14. Stauskas, Ovidijus, 2021. "Uniform Theory for CCE under Heterogeneous Slopes and General Unknown Factors," Working Papers 2021:9, Lund University, Department of Economics.
    15. Arturas Juodis & Simon Reese, 2018. "The Incidental Parameters Problem in Testing for Remaining Cross-section Correlation," Papers 1810.03715, arXiv.org, revised Feb 2021.
    16. Juodis, Artūras & Karabiyik, Hande & Westerlund, Joakim, 2021. "On the robustness of the pooled CCE estimator," Journal of Econometrics, Elsevier, vol. 220(2), pages 325-348.
    17. Joakim Westerlund, 2020. "A cross‐section average‐based principal components approach for fixed‐T panels," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 35(6), pages 776-785, September.
    18. Mingjing Chen, 2021. "Tests for the explanatory power of latent factors," Statistical Papers, Springer, vol. 62(6), pages 2825-2856, December.
    19. Liang Chen & Minyuan Zhang, 2023. "Common Correlated Effects Estimation of Nonlinear Panel Data Models," Papers 2304.13199, arXiv.org.
    20. George Kapetanios & Laura Serlenga & Yongcheol Shin, 2019. "Testing for Correlated Factor Loadings in Cross Sectionally Dependent Panels," SERIES 02-2019, Dipartimento di Economia e Finanza - Università degli Studi di Bari "Aldo Moro", revised Jun 2019.
    21. Ovidijus Stauskas, 2023. "Complete Theory for CCE Under Heterogeneous Slopes and General Unknown Factors," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 85(2), pages 283-303, April.
    22. Ovidijus Stauskas, 2020. "On the limit theory of mixed to unity VARs: Panel setting with weakly dependent errors," Journal of Time Series Analysis, Wiley Blackwell, vol. 41(6), pages 892-898, November.
    23. Hong, Shengjie & Su, Liangjun & Jiang, Tao, 2023. "Profile GMM estimation of panel data models with interactive fixed effects," Journal of Econometrics, Elsevier, vol. 235(2), pages 927-948.
    24. De Vos, Ignace & Stauskas, Ovidijus, 2021. "Bootstrap Improved Inference for Factor-Augmented Regressions with CCE," Working Papers 2021:16, Lund University, Department of Economics.
    25. Chen, Mingjing & Yan, Jingzhou, 2019. "Unbiased CCE estimator for Interactive Fixed Effects panels," Economics Letters, Elsevier, vol. 175(C), pages 1-4.

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    More about this item

    Keywords

    Factor-augmented panel regression; CCE estimation; Moore–Penrose inverse;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C36 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Instrumental Variables (IV) Estimation

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