The Weak Instrument Problem of the System GMM Estimator in Dynamic Panel Data Models

University of Bristol Economics Working Paper No. 07/595

33 Pages Posted: 2 Apr 2007

See all articles by Maurice J. G. Bun

Maurice J. G. Bun

University of Amsterdam (UVA) - Department of Quantitative Economics; Tinbergen Institute

Frank Windmeijer

University of Bristol - Department of Economics; University of Bristol - Leverhulme Centre for Market and Public Organisation (CMPO); Institute for Fiscal Studies (IFS) - Centre for Microdata Methods and Practice

Multiple version iconThere are 2 versions of this paper

Date Written: March 2007

Abstract

The system GMM estimator for dynamic panel data models combines moment conditions for the model in first differences with moment conditions for the model in levels. It has been shown to improve on the GMM estimator in the first differenced model in terms of bias and root mean squared error. However, we show in this paper that in the covariance stationary panel data AR(1) model the expected values of the concentration parameters in the differenced and levels equations for the cross-section at time t are the same when the variances of the individual heterogeneity and idiosyncratic errors are the same. This indicates a weak instrument problem also for the equation in levels. We show that the 2SLS biases relative to that of the OLS biases are then similar for the equations in differences and levels, as are the size distortions of the Wald tests. These results are shown in a Monte Carlo study to extend to the panel data system GMM estimator.

Keywords: Dynamic Panel Data, System GMM, Weak Instruments

JEL Classification: C12, C13, C23

Suggested Citation

Bun, Maurice J. G. and Windmeijer, Frank, The Weak Instrument Problem of the System GMM Estimator in Dynamic Panel Data Models (March 2007). University of Bristol Economics Working Paper No. 07/595, Available at SSRN: https://ssrn.com/abstract=976398 or http://dx.doi.org/10.2139/ssrn.976398

Maurice J. G. Bun

University of Amsterdam (UVA) - Department of Quantitative Economics ( email )

Roetersstraat 11
1018 WB Amsterdam
Netherlands
+31-20-5254257 (Phone)

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Frank Windmeijer (Contact Author)

University of Bristol - Department of Economics ( email )

8 Woodland Road
Bristol BS8 ITN
United Kingdom

University of Bristol - Leverhulme Centre for Market and Public Organisation (CMPO) ( email )

12 Priory Road
Bristol BS8 1TN
United Kingdom

Institute for Fiscal Studies (IFS) - Centre for Microdata Methods and Practice

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London WC1E 7AE, WC1E 7 AE
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