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CESifo Working Paper Details

Common Correlated Effects Estimation of Heterogeneous Dynamic Panel Data Models with Weakly Exogenous Regressors

Alexander Chudik, M. Hashem Pesaran (Website)

CESifo Working Paper No. 4232 (May 2013)

Primary CESifo Category: [12] Empirical and Theoretical Methods

This paper extends the Common Correlated Effects (CCE) approach developed by Pesaran (2006) to heterogeneous panel data models with lagged dependent variable and/or weakly ex-ogenous regressors. We show that the CCE mean group estimator continues to be valid but the following two conditions must be satisfied to deal with the dynamics: a sufficient number of lags of cross section averages must be included in individual equations of the panel, and the number of cross section averages must be at least as large as the number of unobserved common factors. We establish consistency rates, derive the asymptotic distribution, suggest using covariates to deal with the effects of multiple unobserved common factors, and consider jackknife and recursive de-meaning bias correction procedures to mitigate the small sample time series bias. Theoretical findings are accompanied by extensive Monte Carlo experiments, which show that the proposed estimators perform well so long as the time series dimension of the panel is sufficiently large.

Keywords: large panels, lagged dependent variable, cross sectional dependence, coefficient heterogeneity, estimation and inference, common correlated effects, unobserved common factors

JEL Classification:
[C310] Multiple or Simultaneous Equation Models: Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
[C330] Multiple or Simultaneous Equation Models: Models with Panel Data; Longitudinal Data; Spatial Time Series

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