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Spatial correlations in panel data


  • Driscoll, John
  • Kraay, Aart


In many empirical applications involving combined time-series and cross-sectional data, the residuals from different cross-sectional units are likely to be correlated with one another. This is the case in applications in macroeconomics and international economics where the cross-sectional units may be countries, states, or regions observed over time. Spatial correlations among such cross-sections may arise for a number of reasons, ranging from observed common shocks such as terms of trade oil shocks, to unobserved contagion or neighborhood effects which propagate across countries in complex ways. The authors observe that presence of such spatial correlations in residuals complicates standard inference procedures that combine time-series and cross-sectional data since these techniques typically require the assumption that the cross-sectional units are independent. When this assumption is violated, estimates of standard errors are inconsistent, and hence are not useful for inference. And standard correction for spatial correlations will be valid only if spatial correlations are of particular restrictive forms. The authors propose a correlation for spatial correlations that does not require strong assumptions concerning their form and how show it is superior to a number of commonly used alternatives.

Suggested Citation

  • Driscoll, John & Kraay, Aart, 1995. "Spatial correlations in panel data," Policy Research Working Paper Series 1553, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1553

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    References listed on IDEAS

    1. Bruce N. Lehmann, 1986. "Residual Risk Revisited," NBER Working Papers 1908, National Bureau of Economic Research, Inc.
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    5. Al-Najjar, Nabil Ibraheem, 1995. "Decomposition and Characterization of Risk with a Continuum of Random Variables," Econometrica, Econometric Society, vol. 63(5), pages 1195-1224, September.
    6. Kraay, Aart & Ventura, Jaume, 1995. "Trade and fluctuations," Policy Research Working Paper Series 1560, The World Bank.
    7. Froot, Kenneth A., 1989. "Consistent Covariance Matrix Estimation with Cross-Sectional Dependence and Heteroskedasticity in Financial Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 333-355, September.
    8. Case, Anne C, 1991. "Spatial Patterns in Household Demand," Econometrica, Econometric Society, vol. 59(4), pages 953-965, July.
    9. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    10. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
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    Cited by:

    1. Adriana Carolina Silva Arias & Patricia González Román, 2009. "Un análisis espacial de las migraciones internas en Colombia (2000-2005)," REVISTA FACULTAD DE CIENCIAS ECONÓMICAS, UNIVERSIDAD MILITAR NUEVA GRANADA, June.
    2. Conley, T. G., 1999. "GMM estimation with cross sectional dependence," Journal of Econometrics, Elsevier, vol. 92(1), pages 1-45, September.
    3. Yuval Deutsch & Mike Valente, 2013. "Compensating Outside Directors with Stock: The Impact on Non-Primary Stakeholders," Journal of Business Ethics, Springer, vol. 116(1), pages 67-85, August.
    4. Strand, Jonathan R. & Zappile, Tina M., 2015. "Always Vote for Principle, Though You May Vote Alone: Explaining United States Political Support for Multilateral Development Loans," World Development, Elsevier, vol. 72(C), pages 224-239.


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