Large Panels with Common Factors and Spatial Correlations

51 Pages Posted: 27 Sep 2007

See all articles by M. Hashem Pesaran

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

Elisa Tosetti

University of Cambridge - Faculty of Economics and Politics

Date Written: September 2007

Abstract

This paper considers the statistical analysis of large panel data sets where even after conditioning on common observed effects the cross section units might remain dependently distributed. This could arise when the cross section units are subject to unobserved common effects and/or if there are spill over effects due to spatial or other forms of local dependencies. The paper provides an overview of the literature on cross section dependence, introduces the concepts of time-specific weak and strong cross section dependence and shows that the commonly used spatial models are examples of weak cross section dependence. It is then established that the Common Correlated Effects (CCE) estimator of panel data model with a multifactor error structure, recently advanced by Pesaran (2006), continues to provide consistent estimates of the slope coefficient, even in the presence of spatial error processes. Small sample properties of the CCE estimator under various patterns of cross section dependence, including spatial forms, are investigated by Monte Carlo experiments. Results show that the CCE approach works well in the presence of weak and/or strong cross sectionally correlated errors. We also explore the role of certain characteristics of spatial processes in determining the performance of CCE estimators, such as the form and intensity of spatial dependence, and the sparseness of the spatial weight matrix.

Keywords: panels, common correlated effects, strong and weak cross section dependence

JEL Classification: C14, D13, D91, L14, O12

Suggested Citation

Pesaran, M. Hashem and Tosetti, Elisa, Large Panels with Common Factors and Spatial Correlations (September 2007). IZA Discussion Paper No. 3032, CESifo Working Paper Series No. 2103, IEPR Working Paper No. 07.20, Available at SSRN: https://ssrn.com/abstract=1017518

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

Elisa Tosetti

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

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