Market-wide Events and Time Fixed Effects

56 Pages Posted: 8 Oct 2018 Last revised: 23 Aug 2019

See all articles by Elvira Sojli

Elvira Sojli

UNSW Australia Business School, School of Banking and Finance

Wing Wah Tham

University of New South Wales (UNSW)

Wendun Wang

Erasmus University Rotterdam (EUR) - Department of Econometrics

Date Written: September 30, 2018

Abstract

Market-wide events (e.g., financial crises) and regulatory changes empirically have group heterogenous impact on firm outcomes. Inappropriate modelling of the heterogeneity by existing econometric models such as time-fixed effect (assuming a homogenous response to shocks) and industry-year interacted fixed effect (assuming a heterogenous responses to shocks based on industry) is likely to result in biased estimates. This paper investigates the effect of heterogenous responses to common shocks for existing panel studies. We demonstrate theoretically and empirically that ignoring time-varying unobserved heterogeneity that is correlated with regressors in current empirical practices leads to biased estimates and standard errors. To overcome the bias, we propose the use of the "group fixed effect, GFE'' class of models, which produce consistent estimates even under the two-way fixed effect and interacted fixed effect data generating processes. We study the finite sample properties of GFE through simulations and demonstrate its economic importance with two empirical applications. We also extend the GFE class of models to accommodate two-stage least squares estimators. Finally, we provide researchers with guidance and user-written functions in statistical packages to overcome the limitations of existing approaches.

Keywords: Time-varying unobserved heterogeneity; clustering; common shocks; group fixed effects; fixed effects; heterogeneity bias

JEL Classification: G10; G20; G14

Suggested Citation

Sojli, Elvira and Tham, Wing Wah and Wang, Wendun, Market-wide Events and Time Fixed Effects (September 30, 2018). Available at SSRN: https://ssrn.com/abstract=3258048 or http://dx.doi.org/10.2139/ssrn.3258048

Elvira Sojli (Contact Author)

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

Wing Wah Tham

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

Wendun Wang

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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