Factor models in panels with cross-sectional dependence: an application to the extended SIPRI military expenditure data
Strategic interactions between countries, such as arms races, alliances and wider economic and political shocks, can induce strong cross-sectional dependence in models of military expenditures using panel data. If the assumption of cross-sectional independence fails, standard panel estimators such as fixed or random effects can lead to misleading inference. This paper shows how to improve estimation of dynamic, heterogenous, panel models of the demand for military expenditure allowing for cross-sectional dependence in errors using two approaches: Principal Components and Common Correlated Effect estimators. Our results show that it is crucial to allow for cross-section dependence and there are large gains in it by allowing for both dynamics and between country heterogeneity in demand models of military expenditures. Our estimates show that mean group estimation of error correction models using the Common Correlated Effect approach provides an effective modelling framework.
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- Kapetanios, G. & Pesaran, M. Hashem & Yamagata, T., 2011.
"Panels with non-stationary multifactor error structures,"
Journal of Econometrics,
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- George Kapetanios & M. Hashem Pesaran & Takashi Yamagata, 2006. "Panels with Nonstationary Multifactor Error Structures," CESifo Working Paper Series 1788, CESifo Group Munich.
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- Kapetanios, George & Pesaran, M. Hashem & Yamagata, Takashi, 2006. "Panels with Nonstationary Multifactor Error Structures," IZA Discussion Papers 2243, Institute for the Study of Labor (IZA).
- Kapetanios, G. & Pesaran, M.H. & Yamagata, T., 2006. "Panels with Nonstationary Multifactor Error Structures," Cambridge Working Papers in Economics 0651, Faculty of Economics, University of Cambridge.
- George Kapetanios & M. Hashem Pesaran & Takashi Yamagata, 2006. "Panels with Nonstationary Multifactor Error Structures," Working Papers 569, Queen Mary University of London, School of Economics and Finance.
- 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.
- M. Hashem Pesaran, 2004. "Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure," CESifo Working Paper Series 1331, CESifo Group Munich.
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- Jushan Bai, 2009. "Panel Data Models With Interactive Fixed Effects," Econometrica, Econometric Society, vol. 77(4), pages 1229-1279, July.
- J. Paul Dunne & Sam Perlo-Freeman & Ron Smith, 2008. "The Demand For Military Expenditure In Developing Countries: Hostility Versus Capability," Defence and Peace Economics, Taylor & Francis Journals, vol. 19(4), pages 293-302.
- J Paul Dunne & Samuel Perlo-Freeman & Ron P Smith, 2007. "The Demand for Military Expenditure in Developing Countries: Hostility versus Capability," Working Papers 0707, Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol.
- Brauner Jennifer, 2012. "Military Spending and Democratisation," Peace Economics, Peace Science, and Public Policy, De Gruyter, vol. 18(3), pages 1-16, December. Full references (including those not matched with items on IDEAS)
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