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Estimation and Inference in Large Heterogeneous Panels with Cross Section Dependence

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  • Pesaran, H.M.

Abstract

This paper presents a new approach to estimation and inference in panel data models with unobserved common factors possibly correlated with exogenously given individual-specific regressors and/or the observed common effects. The basic idea behind the proposed estimation procedure is to filter the individual-specific regressors by means of (weighted) cross-section aggregates such that, asymptotically as the cross-section dimension (N) tends to infinity, the differential of unobserved common factors are eliminated. The estimation procedure has the advantage that it can be computed by OLS applied to an auxiliary regression where the observed regressors are augmented by cross sectional averages of the dependent variable and the individual specific regressors. It is shown that the proposed correlated common effects (CCE) estimators for the individual-specific regressors (and its pooled counterpart) are asymptotically unbiased as N ? 8, both when T (the time-series dimension) is fixed, and when N and T tend to infinity jointly. Further, the CCE estimators are asymptotically normal for T fixed as N ? 8, and when (N,T) ? 8, jointly provided vT/N ? 0 as (N,T) ? 8. A generalisation of these results to multi-factor structures is also provided.

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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0305.

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Length: 51
Date of creation: Jan 2003
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Handle: RePEc:cam:camdae:0305

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Keywords: cross section dependence; large panels; common correlated effects; heterogeneity; estimation and inference;

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  1. Ahn, Seung Chan & Hoon Lee, Young & Schmidt, Peter, 2001. "GMM estimation of linear panel data models with time-varying individual effects," Journal of Econometrics, Elsevier, Elsevier, vol. 101(2), pages 219-255, April.
  2. Lee, Kevin C & Pesaran, M Hashem, 1993. "The Role of Sectoral Interactions in Wage Determination in the UK Economy," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 103(416), pages 21-55, January.
  3. Pesaran, M. Hashem & Smith, Ron, 1995. "Estimating long-run relationships from dynamic heterogeneous panels," Journal of Econometrics, Elsevier, Elsevier, vol. 68(1), pages 79-113, July.
  4. Timothy G. Conley & Bill Dupor, 2003. "A Spatial Analysis of Sectoral Complementarity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 111(2), pages 311-352, April.
  5. Binder, M. & Hsaio, C. & Pesaran, M.H., 2000. "Estimation and Inference in Short Panel Vector Autoregressions with Unit Roots and Cointegration," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 0003, Faculty of Economics, University of Cambridge.
  6. Mario Forni & Lucrezia Reichlin, 1998. "Let's get real: a factor analytical approach to disaggregated business cycle dynamics," ULB Institutional Repository 2013/10147, ULB -- Universite Libre de Bruxelles.
  7. Donald Robertson & James Symons, 2000. "Factor Residuals in SUR Regressions: Estimating Panels Allowing for Cross Sectional Correlation," CEP Discussion Papers dp0473, Centre for Economic Performance, LSE.
  8. Peter C.B.Phillips & Donggyu Sul, 2002. "Dynamic Panel Estimation and Homogeneity Testing Under Cross Section Dependence," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1362, Cowles Foundation for Research in Economics, Yale University.
  9. James H. Stock & Mark W. Watson, 1998. "Diffusion Indexes," NBER Working Papers 6702, National Bureau of Economic Research, Inc.
  10. Jerry Coakley & Ana-Maria Fuertes & Ron Smith, 2002. "A Principal Components Approach to Cross-Section Dependence in Panels," 10th International Conference on Panel Data, Berlin, July 5-6, 2002, International Conferences on Panel Data B5-3, International Conferences on Panel Data.
  11. Jushan Bai & Serena Ng, 2002. "Determining the Number of Factors in Approximate Factor Models," Econometrica, Econometric Society, Econometric Society, vol. 70(1), pages 191-221, January.
  12. Forni, Mario & Lippi, Marco, 1997. "Aggregation and the Microfoundations of Dynamic Macroeconomics," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198288008, October.
  13. Swamy, P A V B, 1970. "Efficient Inference in a Random Coefficient Regression Model," Econometrica, Econometric Society, Econometric Society, vol. 38(2), pages 311-23, March.
  14. Hsiao, C. & Pesaran, M. H. & Tahmiscioglu, A. K., 1998. "Bayes Estimation of Short-run Coefficients in Dynamic Panel Data Models," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 9804, Faculty of Economics, University of Cambridge.
  15. Holtz-Eakin, Douglas & Newey, Whitney & Rosen, Harvey S, 1988. "Estimating Vector Autoregressions with Panel Data," Econometrica, Econometric Society, Econometric Society, vol. 56(6), pages 1371-95, November.
  16. Kajal Lahiri, 2005. "Analysis of Panel Data," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, Agricultural and Applied Economics Association, vol. 87(4), pages 1093-1095.
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