Breusch, Trevor and Ward, Michael B. and Nguyen, Hoa and Kompas, Tom (2010): On the fixedeffects vector decomposition. Forthcoming in: Political Analysis
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Abstract
This paper analyses the properties of the fixedeffects vector decomposition estimator, an emerging and popular technique for estimating timeinvariant variables in panel data models with unit effects. This estimator was initially motivated on heuristic grounds, and advocated on the strength of favorable Monte Carlo results, but with no formal analysis. We show that the threestage procedure of this decomposition is equivalent to a standard instrumental variables approach, for a specific set of instruments. The instrumental variables representation facilitates the present formal analysis which finds: (1) The estimator reproduces exactly classical fixedeffects estimates for timevarying variables. (2) The standard errors recommended for this estimator are too small for both timevarying and timeinvariant variables. (3) The estimator is inconsistent when the timeinvariant variables are endogenous. (4) The reported sampling properties in the original Monte Carlo evidence are incorrect. (5) We recommend an alternative shrinkage estimator that has superior risk properties to the decomposition estimator, unless the endogeneity problem is known to be small or no relevant instruments exist.
Item Type:  MPRA Paper 

Original Title:  On the fixedeffects vector decomposition 
Language:  English 
Keywords:  panel data models; fixedeffects vector decomposition; instrumental variables; inconsistent estimator; incorrect standard errors; improved shrinkage estimator 
Subjects:  C  Mathematical and Quantitative Methods > C2  Single Equation Models; Single Variables > C23  Models with Panel Data; Longitudinal Data; Spatial Time Series C  Mathematical and Quantitative Methods > C3  Multiple or Simultaneous Equation Models; Multiple Variables > C33  Models with Panel Data; Longitudinal Data; Spatial Time Series 
Item ID:  26767 
Depositing User:  Trevor Breusch 
Date Deposited:  17. Nov 2010 12:42 
Last Modified:  13. Feb 2013 00:25 
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URI:  http://mpra.ub.unimuenchen.de/id/eprint/26767 
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On the fixedeffects vector decomposition. (deposited 18. Mar 2010 18:20)
 On the fixedeffects vector decomposition. (deposited 17. Nov 2010 12:42) [Currently Displayed]