Dynamic Panel Data Models Featuring Endogenous Interaction and Spatially Correlated Errors

Abstract

We extend the three-step generalized methods of moments (GMM) approach of Kapoor, Kelejian, and Prucha (2007), which corrects for spatially correlated errors in static panel data models, by introducing a spatial lag and a one-period lag of the dependent variable as additional explanatory variables. Combining the extended Kapoor, Kelejian, and Prucha (2007) approach with the dynamic panel data model GMM estimators of Arellano and Bond (1991) and Blundell and Bond (1998) and supplementing the dynamic instruments by lagged and weighted exogenous variables as suggested by Kelejian and Robinson (1993) yields new spatial dynamic panel data estimators. The performance of these spatial dynamic panel data estimators is investigated by means of Monte Carlo simulations. We show that differences in bias as well as root mean squared error between spatial GMM estimates and corresponding GMM estimates in which spatial error correlation is ignored are small.

Keywords: Dynamic panel models, spatial lag, spatial error, GMM estimation

JEL Classification: C15, C21, C22, C23