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Unobserved heterogeneity in panel time series models

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  • Coakley, Jerry
  • Fuertes, Ana-Maria
  • Smith, Ron

Abstract

Recently, the large T panel literature has emphasized unobserved, time-varying heterogeneity that may stem from omitted common variables or global shocks that affect each individual unit differently. These latent common factors induce cross-section dependence and may lead to inconsistent regression coefficient estimates if they are correlated with the explanatory variables. Moreover if the process underlying these factors is nonstationary, the individual regressions will be spurious but pooling or averaging across individual estimates still permits consistent estimates of a long-run coefficient. The need to tackle both error cross-section dependence and persistent autocorrelation is motivated by evidence of their pervasiveness found in three well-known international finance and macroeconomic examples. A range of estimators is surveyed and their finite sample properties are examined by means of Monte Carlo experiments. These reveal that a mean group version of the common-correlated-effects estimator stands out as the most robust since it is the preferred choice in rather general (non) stationary settings where regressors and errors share common factors and their factor loadings are possibly dependent. Other approaches which perform reasonably well include the two-way fixed effects, demeaned mean group and between estimators but they are less efficient than the common-correlated-effects estimator.
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Suggested Citation

  • Coakley, Jerry & Fuertes, Ana-Maria & Smith, Ron, 2006. "Unobserved heterogeneity in panel time series models," Computational Statistics & Data Analysis, Elsevier, vol. 50(9), pages 2361-2380, May.
  • Handle: RePEc:eee:csdana:v:50:y:2006:i:9:p:2361-2380
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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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