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Incidental Parameters Bias in Panel Local Projections Non-Monotone Horizon Pattern and Correction

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  • Gerdie Everaert

Abstract

Local projections (LPs) are a widely used method for estimating impulse responses. While LP estimators are consistent as the number of time periods T tends to infinity under standard conditions, they exhibit non-negligible bias in finite samples. This bias is particularly relevant in panel data settings, where the number of individuals N may be large but T relatively small. In this paper, we derive an analytical expression for the incidental-parameters bias in the LP estimator with individual fixed effects. We show that this bias exhibits a non-monotone pattern across the projection horizon: it increases at intermediate horizons, where it can substantially exceed the standard dynamic panel bias even for moderate T, before declining at longer horizons. We propose an iterative bias-correction procedure that, when suitably initialized, effectively eliminates the incidental-parameters bias across the entire projection horizon.

Suggested Citation

  • Gerdie Everaert, 2026. "Incidental Parameters Bias in Panel Local Projections Non-Monotone Horizon Pattern and Correction," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 26/1145, Ghent University, Faculty of Economics and Business Administration.
    • Handle: RePEc:rug:rugwps:26/1145
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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
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General

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