Common Correlated Effects Estimation of Heterogeneous Dynamic Panel Data Models with Weakly Exogenous Regressors

62 Pages Posted: 16 May 2013

See all articles by Alexander Chudik

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas

M. Hashem Pesaran

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

Date Written: May 15, 2013

Abstract

This paper extends the Common Correlated Effects (CCE) approach developed by Pesaran (2006) to heterogeneous panel data models with lagged dependent variable and/or weakly ex-ogenous regressors. We show that the CCE mean group estimator continues to be valid but the following two conditions must be satisfied to deal with the dynamics: a sufficient number of lags of cross section averages must be included in individual equations of the panel, and the number of cross section averages must be at least as large as the number of unobserved common factors. We establish consistency rates, derive the asymptotic distribution, suggest using covariates to deal with the effects of multiple unobserved common factors, and consider jackknife and recursive de-meaning bias correction procedures to mitigate the small sample time series bias. Theoretical findings are accompanied by extensive Monte Carlo experiments, which show that the proposed estimators perform well so long as the time series dimension of the panel is sufficiently large.

Keywords: large panels, lagged dependent variable, cross sectional dependence, coefficient heterogeneity, estimation and inference, common correlated effects, unobserved common factors

JEL Classification: C310, C330

Suggested Citation

Chudik, Alexander and Pesaran, M. Hashem, Common Correlated Effects Estimation of Heterogeneous Dynamic Panel Data Models with Weakly Exogenous Regressors (May 15, 2013). CESifo Working Paper Series No. 4232, Available at SSRN: https://ssrn.com/abstract=2265296

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

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

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