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Untangling Fixed Effects and Constant Regressors

Author

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  • Franc Klaassen

    (University of Amsterdam)

  • Rutger Teulings

    (University of Amsterdam, the Netherlands)

Abstract

Fixed effects (FE) in panel data models overlap each other and prohibit the identification of the impact of ''constant'' regressors. Think of regressors that are constant across countries in a country-time panel with time FE. The traditional approach is to drop some FE and constant regressors by normalizing their impact to zero. We introduce ''untangling normalization'', meaning that we orthogonalize the FE and, if present, the constant regressors. The untangled FE are much easier to interpret. Moreover, the impact of constant regressors can now be estimated, and the untangled FE indicate to what extent the estimates reflect the true value. Our untangled estimates are a linear transformation of the traditional, zero-normalized estimates; no new estimation is needed. We apply the approach to a gravity model for OECD countries' exports to the US. The constant regressors US GDP, world GDP and the US effective exchange rate explain 90% of the time FE, making the latter redundant, so the estimated impacts indeed reflect the true value.

Suggested Citation

  • Franc Klaassen & Rutger Teulings, 2015. "Untangling Fixed Effects and Constant Regressors," Tinbergen Institute Discussion Papers 15-137/VI, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20150137
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    References listed on IDEAS

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    Cited by:

    1. Caselli, Mauro & Schiavo, Stefano & Nesta, Lionel, 2018. "Markups and markdowns," Economics Letters, Elsevier, vol. 173(C), pages 104-107.
    2. repec:hal:spmain:info:hdl:2441/4v3ds3it5k8isrrec0qlf7bt4m is not listed on IDEAS
    3. Beau Soederhuizen & Bert van Stiphout-Kramer & Harro van Heuvelen & Rob Luginbuhl, 2021. "Optimal capital ratios for banks in the euro area," CPB Discussion Paper 429, CPB Netherlands Bureau for Economic Policy Analysis.
    4. Rutger Teulings, 2017. "Brexit and The Impact of Gradual Economic Integration on Export," Tinbergen Institute Discussion Papers 17-075/VI, Tinbergen Institute.
    5. repec:spo:wpmain:info:hdl:2441/4v3ds3it5k8isrrec0qlf7bt4m is not listed on IDEAS
    6. Soederhuizen, Beau & van Heuvelen, Gerrit Hugo & Luginbuhl, Rob & Stiphout-Kramer, Bert van, 2023. "Optimal capital ratios for banks in the euro area," Journal of Financial Stability, Elsevier, vol. 69(C).
    7. Franc Klaassen & Rutger Teulings, 2017. "Untangling Real Gravity," Tinbergen Institute Discussion Papers 17-121/VI, Tinbergen Institute.

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    More about this item

    Keywords

    gravity model; fixed effects; multicollinearity; normalization; orthogonalization;
    All these keywords.

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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