Panel Data Regression

090507

1/22
 Panel Data

Up to now we have analyzed either

Cross-sectional data (data collected on several

individuals/units at one point in time)

or

Time series data (data collected on one individual/unit over

several time periods)

What if we have a combination of these two types of data?

Chapter 16 Panel Data Regression Models 2/22

 Panel data are repeated cross-sections over time, in essence there
will be space as well as time dimensions.

Other names are pooled data, micropanel data, longitudinal data,

event history analysis and cohort analysis

Chapter 16 Panel Data Regression Models 3/22

 Panel Data Examples

The individuals/units can for example be workers, …rms, states or

countries

Annual unemployment rates of each state over several years

Quarterly sales of individual stores over several quarters

Wages for the same worker, working at several di¤erent jobs

Chapter 16 Panel Data Regression Models 4/22

 Panel Data Examples

Some american surveys:

The National Longitudinal Survey of Youth (NLSY) tracks

labor market outcomes for thousands of individuals, beginning
in their teenage years

The Panel Survey of Income Dynamics (PSID) since 1968

collects data on 5000 families about various socioeconomic
and demographic variables

The Survey of Income and Program Participation (SIPP),

conducts interviews four times a year about the respondents
economic conditions

Chapter 16 Panel Data Regression Models 5/22

 Panel Data

Potential gains
take heterogenity into account, get individual-speci…c
estimates
especially suitable to study dynamics of change
study more sophisticated behavioral models
minimize bias due to aggregation

However, panel data also increases the complexity of the analysis.

Chapter 16 Panel Data Regression Models 6/22

 Panel Data

Balanced/unbalanced

Short panel/long panel

Chapter 16 Panel Data Regression Models 7/22

 Panel Data

Two kinds of models:

FIXED EFFECTS MODELS

RANDOM EFFECTS MODELS

The two types of analyses make conceptually contrasting

assumptions about e¤ects as either random or …xed

Chapter 16 Panel Data Regression Models 8/22

 Example with 2 explanatory variables:

Yit = β1 + β2 X2it + β3 X3it + uit

Notice the subscript index it

i stands for the i : th cross-sectional unit, i = 1, ..., N

t stands for the t : th time period, i = 1, ..., T

Chapter 16 Panel Data Regression Models 9/22

 Pooled OLS Regression

Treats all observation as equivalent and OLS as usual

Yit = β1 + β2 X2it + β3 X3it + uit

In this case the error term captures "everything"

Naive, ignores time and space

Chapter 16 Panel Data Regression Models 10/22

 Fixed E¤ects Models with Dummy
Variables

Several kinds of …xed e¤ects models, di¤ers in the asumptions

about

The intercept
The slope coe¢ cients

Chapter 16 Panel Data Regression Models 11/22

 Fixed E¤ects Models with Dummy
Variables
Varies over individuals Varies over time
p
The intercept
The slope coe¢ cients

Di¤erent intercepts for di¤erent individuals β1i

Yit = β1i + β2 X2it + β3 X3it + uit

but each individuals intercept does not vary over time

If the number of individuals is N = 4

Yit = α1 + α2 D2i + α3 D3i + α4 D4i + β2 X2it + β3 X3it + uit

Chapter 16 Panel Data Regression Models 12/22

 Fixed E¤ects Models with Dummy
Variables

Varies over individuals Varies over time

p
The intercept
The slope coe¢ cients

Di¤erent intercepts for di¤erent time periods instead β1t

Yit = β1t + β2 X2it + β3 X3it + uit

If the number of time periods is T = 20

Yit = λ1 + λ2 D2t + λ3 D3t + ... + λ20 D20t + β2 X2it + β3 X3it + uit

Chapter 16 Panel Data Regression Models 13/22

 Fixed E¤ects Models with Dummy
Variables
Varies over individuals Varies over time
p p
The intercept
The slope coe¢ cients

Di¤erent intercepts for di¤erent individuals AND time periods β1it

Yit = β1it + β2 X2it + β3 X3it + uit

For N = 4 and T = 20

Yit = α1 + α2 D2i + α3 D3i + α4 D4i + λ1 + λ2 D2t +

λ3 D3t + ... + λ20 D20t + β2 X2it + β3 X3it + uit

Chapter 16 Panel Data Regression Models 14/22

 Fixed E¤ects Models with Dummy
Variables
Varies over individuals Varies over time
p
The intercept
p
The slope coe¢ cients

Both intercepts and slopes varies over individuals, introduces a lot

of dummy variables

Yit = α1 + α2 D2i + α3 D3i + α4 D4i + β2 X2it + β3 X3it

+γ1 D2i X2it + γ2 D2i X3it + γ3 D3i X2it + γ4 D3i X3it
+γ5 D4i X2it + γ6 D4i X3it + uit

the number of interaction terms is number of dummy variables

number of explanatory variables

Chapter 16 Panel Data Regression Models 15/22

 Fixed E¤ects Models with Dummy
Variables

Both intercepts and slopes varies over individuals and time

requires even more variables

Chapter 16 Panel Data Regression Models 16/22

 Fixed E¤ects Models

Cautions

a lot of dummy variables

) less df
) increased risk of multicollinearity

have to re‡ect on the assumptions about the error term uit

- heteroscedasticity?
- autocorrelation?

easily gets complicated when both time and space dimensions

Chapter 16 Panel Data Regression Models 17/22

 Random E¤ects Models

Now, in the Random E¤ects Model

Yit = β1i + β2 X2it + β3 X3it + uit

the intercepts/e¤ects β1i are assumed to be random variables with

mean value
E ( β1i ) = β1
and the intercept value for individual i can be expressed as

β1i = β1 + εi i = 1, ..., N

where E (εi ) = 0 and Var (εi ) = σ2ε

Chapter 16 Panel Data Regression Models 18/22

 Random E¤ects Models

each individual in the sample is considered to be a drawing from an

in…nite (or "close to") population of individuals which share the
common mean value β1

Yit = β1 + β2 X2it + β3 X3it + εi + uit

Yit = β1 + β2 X2it + β3 X3it + wit

The error term wit consists of two components, random e¤ects

models are sometimes called error components models

Chapter 16 Panel Data Regression Models 19/22

 Random E¤ects Models

Assumptions about the error components

9
εi N 0, σ2ε >
>
>
>
>
>
>
E ( εi εj ) = 0 for i 6= j >
>
>
>
=
uit N 0, σ2u
>
>
>
>
E (uit uis ) = E (uit uit ) = E (uit ujs ) = 0 for i 6= j t 6= s >
>
>
>
>
>
>
;
E (εi uit ) = 0

Chapter 16 Panel Data Regression Models 20/22

 Random E¤ects Models

8
> E (wit ) = 0
>
>
>
<
) Var (wit ) = σ2ε + σ2u
>
>
>
>
: σ2ε
Corr (wit , wis ) = σ2ε +σ2u

Chapter 16 Panel Data Regression Models 21/22

 Random E¤ects vs Fixed E¤ects

depends on

whether or not the individuals can be viewed as a random

sample from a large population

E (εi Xi ) = 0?
If yes: random e¤ects, if no: …xed e¤ects
the relation between T and N
- for large T and small N not a big di¤erence
- for small T and large N random e¤ects estimators are more
e¢ cient than …xed e¤ects (if the assumptions hold)

Chapter 16 Panel Data Regression Models 22/22