Breusch, Trevor and Ward, Michael B and Nguyen, Hoa and Kompas, Tom (2010): On the fixedeffects vector decomposition.
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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  Panel Data Models ; Spatiotemporal Models C  Mathematical and Quantitative Methods > C3  Multiple or Simultaneous Equation Models ; Multiple Variables > C33  Panel Data Models ; Spatiotemporal Models 
Item ID:  21452 
Depositing User:  Trevor Breusch 
Date Deposited:  18. Mar 2010 18:20 
Last Modified:  30. Dec 2015 10:08 
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URI:  https://mpra.ub.unimuenchen.de/id/eprint/21452 
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