Robust Standard Errors in Transformed Likelihood Estimation of Dynamic Panel Data Models with Cross-Sectional Heteroskedasticity

53 Pages Posted: 29 Apr 2012 Last revised: 22 Mar 2015

See all articles by Kazuhiko Hayakawa

Kazuhiko Hayakawa

Hiroshima University

M. Hashem Pesaran

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

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Date Written: November 4, 2014

Abstract

This paper extends the transformed maximum likelihood approach for estimation of dynamic panel data models by Hsiao, Pesaran and Tahmiscioglu (2002) to the case where the errors are cross-sectionally heteroskedastic. This extension is not trivial due to the incidental parameters problem that arises, and its implications for estimation and inference. We approach the problem by working with a mis-specified homoskedastic model. It is shown that the transformed maximum likelihood estimator continues to be consistent even in the presence of cross-sectional heteroskedasticity. We also obtain standard errors that are robust to cross-sectional heteroskedasticity of unknown form. By means of Monte Carlo simulation, we investigate the finite sample behavior of the transformed maximum likelihood estimator and compare it with various GMM estimators proposed in the literature. Simulation results reveal that, in terms of median absolute errors and accuracy of inference, the transformed likelihood estimator outperforms the GMM estimators in almost all cases.

Keywords: dynamic panels, cross-sectional heteroskedasticity, Monte Carlo simulation, GMM estimation

JEL Classification: C12, C13, C23

Suggested Citation

Hayakawa, Kazuhiko and Pesaran, M. Hashem, Robust Standard Errors in Transformed Likelihood Estimation of Dynamic Panel Data Models with Cross-Sectional Heteroskedasticity (November 4, 2014). Available at SSRN: https://ssrn.com/abstract=2047069 or http://dx.doi.org/10.2139/ssrn.2047069

Kazuhiko Hayakawa (Contact Author)

Hiroshima University ( email )

Japan

M. Hashem Pesaran

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

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