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Grouped Effects Estimators in Fixed Effects Models

Posted: 5 Dec 2010  

Alan Bester

University of Chicago Graduate School of Business

Christian Hansen

University of Chicago - Booth School of Business - Econometrics and Statistics

Date Written: February 24, 2009

Abstract

We consider estimation of nonlinear panel data models with common and individual specific parameters. Fixed effects estimators are known to suffer from the incidental parameters problem, which can lead to large biases in estimates of common parameters. Pooled estimators, which ignore heterogeneity across individuals, are also generally inconsistent. We assume that individuals in our data are grouped on multiple levels. These groups may be based on some external classification (for example, SIC codes), geographic location (census tract, county, state, etc.), or perhaps based on observable right hand side variables, and may be nested (hierarchical) or non-nested. We consider "group effects" estimators, where individual specific parameters are assumed common across groups at some level. We provide conditions under which group effects estimates of common parameters are asymptotically unbiased and normal. Our conditions suggest a tradeoff between two sources of bias, one due to incidental parameters and the other due to misspecification of unobserved heterogeneity. Our findings suggest that one may wish to control for heterogeneity at the group level even when individual specific effects are present. These findings are confirmed in a Monte Carlo study.

Keywords: Fixed Effects, Panel Data, Hierarchical Models

JEL Classification: C10, C13, C23

Suggested Citation

Bester, Alan and Hansen, Christian, Grouped Effects Estimators in Fixed Effects Models (February 24, 2009). Available at SSRN: https://ssrn.com/abstract=1719684

Alan Bester

University of Chicago Graduate School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-1714 (Phone)

Christian Hansen (Contact Author)

University of Chicago - Booth School of Business - Econometrics and Statistics ( email )

Chicago, IL 60637
United States
773-834-1702 (Phone)

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