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Using Backward Means to Eliminate Individual Effects from Dynamic Panels

  • G. EVERAERT

    ()

The within-groups estimator is inconsistent in dynamic panels with fixed T since the sample mean used to eliminate the individual effects from the lagged dependent variable is correlated with the error term. This paper suggests to eliminate individual effects from an AR(1) panel using backward means as an alternative to sample means. Using orthogonal deviations of the lagged dependent variable from its backward mean yields an estimator that is still inconsistent for fixed T but the inconsistency is shown to be negligibly small. A Monte Carlo simulation shows that this alternative estimator has superior small sample properties compared to conventional fixed effects, bias-corrected fixed effects and GMM estimators. Interestingly, it is also consistent for fixed T in the specific cases where (i) T = 2, (ii) the AR parameter is 0 or 1, (iii) the variance of the individual effects is zero.

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File URL: http://wps-feb.ugent.be/Papers/wp_09_553.pdf
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Paper provided by Ghent University, Faculty of Economics and Business Administration in its series Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium with number 09/553.

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Length: 23 pages
Date of creation: Jan 2009
Date of revision:
Handle: RePEc:rug:rugwps:09/553
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Web page: http://www.ugent.be/eb

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  1. Blundell, R. & Bond, S., 1995. "Initial Conditions and Moment Restrictions in Dynamic Panel Data Models," Economics Papers 104, Economics Group, Nuffield College, University of Oxford.
  2. Maurice J. G. Bun, 2003. "Bias Correction in the Dynamic Panel Data Model with a Nonscalar Disturbance Covariance Matrix," Econometric Reviews, Taylor & Francis Journals, vol. 22(1), pages 29-58, February.
  3. Anderson, T. W. & Hsiao, Cheng, 1982. "Formulation and estimation of dynamic models using panel data," Journal of Econometrics, Elsevier, vol. 18(1), pages 47-82, January.
  4. Alvarez, J. & Arellano, M., 1998. "The Time Series and Cross-Section Asymptotics of Dynamic Panel Data Estimators," Papers 9808, Centro de Estudios Monetarios Y Financieros-.
  5. Kiviet, Jan F., 1995. "On bias, inconsistency, and efficiency of various estimators in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 68(1), pages 53-78, July.
  6. Bun, Maurice J.G. & Carree, Martin A., 2005. "Bias-Corrected Estimation in Dynamic Panel Data Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 23, pages 200-210, April.
  7. Bun, Maurice J.G. & Kiviet, Jan F., 2006. "The effects of dynamic feedbacks on LS and MM estimator accuracy in panel data models," Journal of Econometrics, Elsevier, vol. 132(2), pages 409-444, June.
  8. 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.
  9. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  10. Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, vol. 49(6), pages 1417-26, November.
  11. Everaert, Gerdie & Pozzi, Lorenzo, 2007. "Bootstrap-based bias correction for dynamic panels," Journal of Economic Dynamics and Control, Elsevier, vol. 31(4), pages 1160-1184, April.
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