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Panel Analysis

Panel analysis is a statistical method used in social science and econometrics to analyze two-dimensional panel data collected over time and over individuals. There are three main approaches to panel data analysis: independently pooled panels which assume no unique attributes of individuals; fixed effects models which assume unique time-invariant attributes of individuals; and random effects models which assume unique time-constant attributes are not correlated with other variables. The selection between these methods depends on the objective of the analysis and issues with explanatory variable exogeneity.

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25 views

Panel Analysis

Panel analysis is a statistical method used in social science and econometrics to analyze two-dimensional panel data collected over time and over individuals. There are three main approaches to panel data analysis: independently pooled panels which assume no unique attributes of individuals; fixed effects models which assume unique time-invariant attributes of individuals; and random effects models which assume unique time-constant attributes are not correlated with other variables. The selection between these methods depends on the objective of the analysis and issues with explanatory variable exogeneity.

Uploaded by

harrison9
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© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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Panel analysis

Panel (data) analysis is a statistical method, widely used in social science, epidemiology, and econometrics
to analyze two-dimensional (typically cross sectional and longitudinal) panel data.[1] The data are usually
collected over time and over the same individuals and then a regression is run over these two dimensions.
Multidimensional analysis is an econometric method in which data are collected over more than two
dimensions (typically, time, individuals, and some third dimension).[2]

A common panel data regression model looks like , where is the dependent
variable, is the independent variable, and are coefficients, and are indices for individuals and time.
The error is very important in this analysis. Assumptions about the error term determine whether we
speak of fixed effects or random effects. In a fixed effects model, is assumed to vary non-stochastically
over or making the fixed effects model analogous to a dummy variable model in one dimension. In a
random effects model, is assumed to vary stochastically over or requiring special treatment of the
error variance matrix. [3]

Panel data analysis has three more-or-less independent approaches:

independently pooled panels;


random effects models;
fixed effects models or first differenced models.

The selection between these methods depends upon the objective of the analysis, and the problems
concerning the exogeneity of the explanatory variables.

Independently pooled panels


Key assumption:
There are no unique attributes of individuals within the measurement set, and no universal effects across
time.

Fixed effect models


Key assumption:
There are unique attributes of individuals that do not vary over time. That is, the unique attributes for a
given individual are time invariant. These attributes may or may not be correlated with the individual
dependent variables yi. To test whether fixed effects, rather than random effects, is needed, the Durbin–
Wu–Hausman test can be used.

Random effect models


Key assumption:
There are unique, time constant attributes of individuals that are not correlated with the individual
regressors. Pooled OLS can be used to derive unbiased and consistent estimates of parameters even when
time constant attributes are present, but random effects will be more efficient.
Fixed effects is a feasible generalised least squares technique which is asymptotically more efficient than
Pooled OLS when time constant attributes are present. Random effects adjusts for the serial correlation
which is induced by unobserved time constant attributes.

Models with instrumental variables


In the standard random effects (RE) and fixed effects (FE) models, independent variables are assumed to be
uncorrelated with error terms. Provided the availability of valid instruments, RE and FE methods extend to
the case where some of the explanatory variables are allowed to be endogenous. As in the exogenous
setting, RE model with Instrumental Variables (REIV) requires more stringent assumptions than FE model
with Instrumental Variables (FEIV) but it tends to be more efficient under appropriate conditions.[4]

To fix ideas, consider the following model:

where is unobserved unit-specific time-invariant effect (call it unobserved effect) and can be
correlated with for s possibly different from t. Suppose there exists a set of valid instruments
.

In REIV setting, key assumptions include that is uncorrelated with as well as for . In
fact, for REIV estimator to be efficient, conditions stronger than uncorrelatedness between instruments and
unobserved effect are necessary.

On the other hand, FEIV estimator only requires that instruments be exogenous with error terms after
conditioning on unobserved effect i.e. .[4] The FEIV condition allows for arbitrary
correlation between instruments and unobserved effect. However, this generality does not come for free:
time-invariant explanatory and instrumental variables are not allowed. As in the usual FE method, the
estimator uses time-demeaned variables to remove unobserved effect. Therefore, FEIV estimator would be
of limited use if variables of interest include time-invariant ones.

The above discussion has parallel to the exogenous case of RE and FE models. In the exogenous case, RE
assumes uncorrelatedness between explanatory variables and unobserved effect, and FE allows for arbitrary
correlation between the two. Similar to the standard case, REIV tends to be more efficient than FEIV
provided that appropriate assumptions hold.[4]

Dynamic panel models


In contrast to the standard panel data model, a dynamic panel model also includes lagged values of the
dependent variable as regressors. For example, including one lag of the dependent variable generates:

The assumptions of the fixed effect and random effect models are violated in this setting. Instead,
practitioners use a technique like the Arellano–Bond estimator.

See also
Panel study
Hausman test
Factor analysis

References
1. Maddala, G. S. (2001). Introduction to Econometrics (Third ed.). New York: Wiley. ISBN 0-
471-49728-2.
2. Davies, A.; Lahiri, K. (1995). "A New Framework for Testing Rationality and Measuring
Aggregate Shocks Using Panel Data". Journal of Econometrics. 68 (1): 205–227.
doi:10.1016/0304-4076(94)01649-K (https://doi.org/10.1016%2F0304-4076%2894%290164
9-K).
3. Hsiao, C.; Lahiri, K.; Lee, L.; et al., eds. (1999). Analysis of Panels and Limited Dependent
Variable Models. Cambridge: Cambridge University Press. ISBN 0-521-63169-6.
4. Wooldridge, J.M., Econometric Analysis of Cross Section and Panel Data, MIT Press,
Cambridge, Mass.

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