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On the Effect of Nonstationary Initial Conditions in Dynamic Panel Data Models

  • Kazuhiko Hayakawa

In this paper, we consider dynamic panel data models with possibly nonstationary initial conditions. We derive the asymptotic properties of the GMM estimators with various kinds of instruments when both N and T are large, where N and T denote the dimensions of the cross section and time series. We find that when initial conditions are nonstationary and the degree of heterogeneity, which is measured by the variance ratio of individual effects to the disturbances, is large, the biases and variances of the GMM estimators become small. We demonstrate that this is because the correlation between the lagged dependent variable and instruments gets larger due to the unremoved individual effects. This implies that the instruments become strong when initial conditions are nonstationary and the degree of heterogeneity is large. For the purpose of comparison, we also derive the asymptotic properties of the within groups and the LIML estimators. Numerical studies are conducted to assess the properties of these estimators.

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File URL: http://hi-stat.ier.hit-u.ac.jp/research/discussion/2007/pdf/D07-245.pdf
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Paper provided by Institute of Economic Research, Hitotsubashi University in its series Hi-Stat Discussion Paper Series with number d07-245.

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Date of creation: Mar 2008
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Handle: RePEc:hst:hstdps:d07-245
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  10. Hayakawa, Kazuhiko, 2007. "Small sample bias properties of the system GMM estimator in dynamic panel data models," Economics Letters, Elsevier, vol. 95(1), pages 32-38, April.
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  12. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July.
  13. Okui, Ryo, 2009. "The optimal choice of moments in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 151(1), pages 1-16, July.
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  17. Hause, John C, 1980. "The Fine Structure of Earnings and the On-the-Job Training Hypothesis," Econometrica, Econometric Society, vol. 48(4), pages 1013-29, May.
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