Instrumental Variable Estimation of Dynamic Linear Panel Data Models with Defactored Regressors and a Multifactor Error Structure

98 Pages Posted: 26 Feb 2018 Last revised: 11 May 2019

See all articles by Milda Norkute

Milda Norkute

Lund University

Vasilis Sarafidis

BI Norwegian Business School

Takashi Yamagata

University of York - Department of Economics and Related Studies; Osaka University - Institute of Social and Economic Research

Guowei Cui

Huazhong University of Science and Technology (Formerly Tongi Medical University)

Date Written: April 30, 2019

Abstract

This paper develops two instrumental variable (IV) estimators for dynamic panel data models with exogenous covariates and a multifactor error structure when both crosssectional and time series dimensions, N and T respectively, are large. Our approach initially projects out the common factors from the exogenous covariates of the model, and constructs instruments based on this defactored covariates. For models with homogeneous slope coe_cients, we propose a two-step IV estimator: the _rst step IV estimator is obtained using the defactored covariates as instruments. In the second step, the entire model is defactored by the extracted factors from the residuals of the _rst step estimation and subsequently obtain the _nal IV estimator. For models with heterogeneous slope coe _cients, we propose a mean-group type estimator, which is the cross-sectional average of _rst-step IV estimators of cross-section speci_c slopes. It is noteworthy that our estimators do not require us to seek for instrumental variables outside the model. Furthermore, our estimators are linear hence computationally robust and inexpensive. Moreover, they require no bias correction, and they are not subject to the small sample bias of least squares type estimators. The _nite sample performances of the proposed estimators and associated statistical tests are investigated, and the results show that the estimators and the tests perform well even for small N and T.

Keywords: method of moments, dynamic panel data, cross-sectional dependence, factor model

JEL Classification: C13, C15, C23

Suggested Citation

Norkute, Milda and Sarafidis, Vasilis and Yamagata, Takashi and cui, guowei, Instrumental Variable Estimation of Dynamic Linear Panel Data Models with Defactored Regressors and a Multifactor Error Structure (April 30, 2019). ISER Discussion Paper No. 1019, Available at SSRN: https://ssrn.com/abstract=3123490 or http://dx.doi.org/10.2139/ssrn.3123490

Milda Norkute

Lund University ( email )

Box 117
Lund, SC Skane S221 00
Sweden

Vasilis Sarafidis

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, Victoria 0484
Norway
0484 (Fax)

HOME PAGE: http://sites.google.com/view/vsarafidis

Takashi Yamagata (Contact Author)

University of York - Department of Economics and Related Studies ( email )

Heslington
York, YO1 5DD
United Kingdom

Osaka University - Institute of Social and Economic Research ( email )

6-1, Mihogaoka
Suita, Osaka 567-0047
Japan

Guowei Cui

Huazhong University of Science and Technology (Formerly Tongi Medical University) ( email )

Wuhan, Hubei 430074
China
18171270610 (Phone)

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