The Covariance Transformation And the Instrumental Variables Estimator of the Fixed Effects Model
AbstractThe covariance transformation is a useful and often necessary procedure to estimate the fixed effects model. When some explanatory variables are contemporaneously correlated with the disturbance term, the covariance transformation can be used in conjunction with an instrumental variables procedure to obtain a consistent estimator. This paper describes how to correctly compute the IV estimator as a two stage least squares estimator. In addition, I show that if the IV estimator is incorrectly computed using a two stage least squares approach where the covariance transformation is not applied until the second stage, the resulting estimator is not in general consistent.
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Bibliographic InfoPaper provided by Levy Economics Institute, The in its series Economics Working Paper Archive with number wp_28.
Date of creation: Jul 1989
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