Instrumental Variable Estimation of Large Panel Data Models with Common Factors

26 Pages Posted: 21 Sep 2020

See all articles by Sebastian Kripfganz

Sebastian Kripfganz

University of Exeter Business School - Department of Economics

Vasilis Sarafidis

Monash University

Date Written: August 6, 2020

Abstract

This article introduces the xtivdfreg command in Stata, which implements a general Instrumental Variables (IV) approach for estimating large panel data models with unobserved common factors or interactive effects, as developed by Norkute et al. (2020) and Cui et al. (2020a). The underlying idea of this approach is to project out the common factors from exogenous co-variates using principal components analysis, and run IV regression using de-factored co-variates as instruments. The resulting "IVDF" method is valid for models with homogeneous or heterogeneous slope coefficients, and has several advantages relative to existing popular approaches.

In addition, the xtivdfreg command extends the IVDF approach in two major ways. Firstly, the algorithm accommodates estimation of unbalanced panels. Secondly, the algorithm permits highly
flexible instrumentation strategies.

It is shown that when one imposes zero factors, the xtivdfreg command can replicate the results of the popular ivregress Stata command. Notably, xtivdfreg also permits estimation of the two-way error components panel data model with heterogeneous slope coefficients.

Keywords: Large Panels, Instrumental Variables, Common Factors, Interactive Effects, Cross-Sectional Dependence, Defactoring, Xtivdfreg

JEL Classification: C23, C26, C55, C87

Suggested Citation

Kripfganz, Sebastian and Sarafidis, Vasilis, Instrumental Variable Estimation of Large Panel Data Models with Common Factors (August 6, 2020). Available at SSRN: https://ssrn.com/abstract=3668588 or http://dx.doi.org/10.2139/ssrn.3668588

Sebastian Kripfganz

University of Exeter Business School - Department of Economics ( email )

Streatham Court
Exeter, EX4 4RJ
United Kingdom

Vasilis Sarafidis (Contact Author)

Monash University ( email )

Dandenong Road
Caulfield East, Victoria 3145
Australia

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