Estimation of Short Dynamic Panels in The Presence of Cross-Sectional Dependence and Dynamic Heterogeneity

38 Pages Posted: 14 Nov 2015

See all articles by Robert Gilhooly

Robert Gilhooly

Bank of England

Martin R. Weale

National Institute of Economic and Social Research (NIESR)

Tomasz Wieladek

Bank of England

Date Written: December 12, 2012

Abstract

We propose a Bayesian approach to dynamic panel estimation in the presence of cross-sectional dependence and dynamic heterogeneity which is suitable for inference in short panels, unlike alternative estimators. Monte Carlo simulations indicate that our estimator produces less bias, and a lower root mean squared error, than existing estimators. The method is illustrated by estimating a panel VAR on sector level data for labour productivity and hours worked growth for Canada, Germany, France, Italy, the UK and the US from 1992 Q1 to 2011 Q3. We use historical decompositions to examine the determinants of recent output growth in each country. This exercise demonstrates that failure to take cross-sectional dependence into account leads to highly misleading results.

Keywords: Bayesian dynamic panel estimator, dynamic heterogeneity, cross-sectional dependence, labour

JEL Classification: C11, C31, C33

Suggested Citation

Gilhooly, Robert and Weale, Martin R. and Wieladek, Tomasz, Estimation of Short Dynamic Panels in The Presence of Cross-Sectional Dependence and Dynamic Heterogeneity (December 12, 2012). Bank of England Working Paper No. 38. Available at SSRN: https://ssrn.com/abstract=2689565 or http://dx.doi.org/10.2139/ssrn.2689565

Robert Gilhooly (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Martin R. Weale

National Institute of Economic and Social Research (NIESR) ( email )

2 Dean Trench Street
Smith Square
London SW1P 3HE
United Kingdom

HOME PAGE: http://www.niesr.ac.uk/

Tomasz Wieladek

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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