IDEAS home Printed from https://ideas.repec.org/p/arx/papers/2402.09928.html
   My bibliography  Save this paper

When Can We Use Two-Way Fixed-Effects (TWFE): A Comparison of TWFE and Novel Dynamic Difference-in-Differences Estimators

Author

Listed:
  • Tobias Ruttenauer
  • Ozan Aksoy

Abstract

The conventional Two-Way Fixed-Effects (TWFE) estimator has come under scrutiny lately. Recent literature has revealed potential shortcomings of TWFE when the treatment effects are heterogeneous. Scholars have developed new advanced dynamic Difference-in-Differences (DiD) estimators to tackle these potential shortcomings. However, confusion remains in applied research as to when the conventional TWFE is biased and what issues the novel estimators can and cannot address. In this study, we first provide an intuitive explanation of the problems of TWFE and elucidate the key features of the novel alternative DiD estimators. We then systematically demonstrate the conditions under which the conventional TWFE is inconsistent. We employ Monte Carlo simulations to assess the performance of dynamic DiD estimators under violations of key assumptions, which likely happens in applied cases. While the new dynamic DiD estimators offer notable advantages in capturing heterogeneous treatment effects, we show that the conventional TWFE performs generally well if the model specifies an event-time function. All estimators are equally sensitive to violations of the parallel trends assumption, anticipation effects or violations of time-varying exogeneity. Despite their advantages, the new dynamic DiD estimators tackle a very specific problem and they do not serve as a universal remedy for violations of the most critical assumptions. We finally derive, based on our simulations, recommendations for how and when to use TWFE and the new DiD estimators in applied research.

Suggested Citation

  • Tobias Ruttenauer & Ozan Aksoy, 2024. "When Can We Use Two-Way Fixed-Effects (TWFE): A Comparison of TWFE and Novel Dynamic Difference-in-Differences Estimators," Papers 2402.09928, arXiv.org, revised Apr 2024.
    • Handle: RePEc:arx:papers:2402.09928
    as

    Download full text from publisher

    File URL: http://arxiv.org/pdf/2402.09928
    File Function: Latest version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Janet Currie & John Voorheis & Reed Walker, 2023. "What Caused Racial Disparities in Particulate Exposure to Fall? New Evidence from the Clean Air Act and Satellite-Based Measures of Air Quality," American Economic Review, American Economic Association, vol. 113(1), pages 71-97, January.
    2. Jeffrey M Wooldridge, 2010. "Econometric Analysis of Cross Section and Panel Data," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232588, December.
    3. Albert Chiu & Xingchen Lan & Ziyi Liu & Yiqing Xu, 2023. "What To Do (and Not to Do) with Causal Panel Analysis under Parallel Trends: Lessons from A Large Reanalysis Study," Papers 2309.15983, arXiv.org.
    4. Seth M. Freedman & Alex Hollingsworth & Kosali I. Simon & Coady Wing & Madeline Yozwiak, 2023. "Designing Difference in Difference Studies With Staggered Treatment Adoption: Key Concepts and Practical Guidelines," NBER Working Papers 31842, National Bureau of Economic Research, Inc.
    5. Janet Currie & Lucas Davis & Michael Greenstone & Reed Walker, 2015. "Environmental Health Risks and Housing Values: Evidence from 1,600 Toxic Plant Openings and Closings," American Economic Review, American Economic Association, vol. 105(2), pages 678-709, February.
    6. Joshua D. Angrist & Jörn-Steffen Pischke, 2015. "The path from cause to effect: mastering 'metrics," CentrePiece - The magazine for economic performance 442, Centre for Economic Performance, LSE.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Chang, Hung-Hao & Lee, Brian & Hsieh, Yi-Ting, 2021. "Participation in afforestation programs and the distribution of forest farm income," Forest Policy and Economics, Elsevier, vol. 129(C).
    2. Timothy J. Halliday & Rachel Inafuku & Lester Lusher & Aureo de Paula, 2022. "VOG: Using Volcanic Eruptions to Estimate the Impact of Air Pollution on Student Learning Outcomes," Working Papers 202203, University of Hawaii at Manoa, Department of Economics.
    3. Duque, Valentina & Gilraine, Michael, 2022. "Coal use, air pollution, and student performance," Journal of Public Economics, Elsevier, vol. 213(C).
    4. Rivera, Nathaly M. & Loveridge, Scott, 2022. "Coal-to-gas fuel switching and its effects on housing prices," Energy Economics, Elsevier, vol. 106(C).
    5. Dmitry Arkhangelsky & Guido Imbens, 2023. "Causal Models for Longitudinal and Panel Data: A Survey," Papers 2311.15458, arXiv.org, revised Mar 2024.
    6. Edith Aguirre, 2019. "Domestic violence and women’s earnings: Does frequency matter?," Discussion Papers 19/16, Department of Economics, University of York.
    7. Reinhold Kosfeld & Timo Mitze & Johannes Rode & Klaus Wälde, 2021. "The Covid‐19 containment effects of public health measures: A spatial difference‐in‐differences approach," Journal of Regional Science, Wiley Blackwell, vol. 61(4), pages 799-825, September.
    8. Emmanuelle Lavaine, 2019. "Environmental risk and differentiated housing values," Post-Print hal-02048712, HAL.
    9. Kettlewell, Nathan & Siminski, Peter, 2020. "Optimal Model Selection in RDD and Related Settings Using Placebo Zones," IZA Discussion Papers 13639, Institute of Labor Economics (IZA).
    10. Ruchi Avtar & Kristian S. Blickle & Rajashri Chakrabarti & Janavi Janakiraman & Maxim L. Pinkovskiy, 2023. "Understanding the Linkages between Climate Change and Inequality in the United States," Economic Policy Review, Federal Reserve Bank of New York, vol. 29(1), pages 1-39, June.
    11. Goodman-Bacon, Andrew, 2021. "Difference-in-differences with variation in treatment timing," Journal of Econometrics, Elsevier, vol. 225(2), pages 254-277.
    12. Francesco Biancalani & Dirk Czarnitzki & Massimo Riccaboni, 2022. "The Italian Start Up Act: a microeconometric program evaluation," Small Business Economics, Springer, vol. 58(3), pages 1699-1720, March.
    13. Cai, Jingjing & De Silva, Dakshina G. & Slechten, Aurelie, 2021. "Effects of oil booms on the local environment," Energy Economics, Elsevier, vol. 101(C).
    14. James D. Adams & Albert N. Link, 2018. "The structure and performance of U.S. research joint ventures: inferences and implications from the Advanced Technology Program," Economics of Innovation and New Technology, Taylor & Francis Journals, vol. 27(5-6), pages 551-575, August.
    15. Hollingsworth, Alex J. & Konisky, David M. & Zirogiannis, Nikolaos, 2021. "The health consequences of excess emissions: Evidence from Texas," Journal of Environmental Economics and Management, Elsevier, vol. 108(C).
    16. Hasan, Iftekhar & Krause, Thomas & Manfredonia, Stefano & Noth, Felix, 2022. "Banking market deregulation and mortality inequality," Bank of Finland Research Discussion Papers 14/2022, Bank of Finland.
    17. Joshua S. Graff Zivin & Gregor Singer, 2022. "Disparities in Pollution Capitalization Rates: The Role of Direct and Systemic Discrimination," NBER Working Papers 30814, National Bureau of Economic Research, Inc.
    18. Duque, Valentina & Gilraine, Michael, 2020. "Coal Use and Student Performance," Working Papers 2020-07, University of Sydney, School of Economics.
    19. Albouy, David & Christensen, Peter & Sarmiento-Barbieri, Ignacio, 2020. "Unlocking amenities: Estimating public good complementarity," Journal of Public Economics, Elsevier, vol. 182(C).
    20. Bernard Black & Woochan Kim & Julia Nasev, 2021. "The Effect of Board Structure on Firm Disclosure and Behavior: A Case Study of Korea and a Comparison of Research Designs," Journal of Empirical Legal Studies, John Wiley & Sons, vol. 18(2), pages 328-376, June.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:arx:papers:2402.09928. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: arXiv administrators (email available below). General contact details of provider: http://arxiv.org/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.