1 An Introduction To Panel Data Methods

The Bank of England does not accept any liability for misleading or inaccurate information or omissions in the information
provided.
haroon.mumtaz@bankofengland.co.uk haroon.mumtaz@bankofengland.co.uk Inflation Targeting Inflation Targeting Bank of England Bank of England
An introduction to Panel data
methods
The Bank of England does not accept any liability for misleading or inaccurate information or omissions in the information provided.
Contents
Preliminary background
Static panel data
Dynamic panels
Panel time series
What is Panel data?
Year Firm Investment Value of the firm
1950 1 642.9 3755.6
1951 1 755.9 4833
1952 1 891.2 4924.9
1953 1 1304.4 6241.7
1954 1 1486.7 5593.6
1950 2 100.66 693.5
1951 2 160.62 809
1952 2 145 727
1953 2 174.93 1001.5
1954 2 172.49 703.2
1950 3 93.5 1610.5
1951 3 135.2 1819.4
1952 3 157.3 2079.7
1953 3 179.5 2371.6
1954 3 189.6 2759.9
1950 4 32.24 635.2
1951 4 54.38 723.8
1952 4 71.78 864.1
1953 4 90.08 1193.5
1954 4 68.6 1188.9
1950 5 418.8 1677.4
1951 5 588.2 2289.5
1952 5 645.2 2159.4
1953 5 641 2031.3
1954 5 459.3 2115.5
What is Panel Data?
1950 1 642.9 3755.6
1951 1 755.9 4833
1952 1 891.2 4924.9
1953 1 1304.4 6241.7
1954 1 1486.7 5593.6
1950 2 100.66 693.5
1951 2 160.62 809
1952 2 145 727
1953 2 174.93 1001.5
1954 2 172.49 703.2
1950 3 93.5 1610.5
1951 3 135.2 1819.4
1952 3 157.3 2079.7
1953 3 179.5 2371.6
1954 3 189.6 2759.9
1950 4 32.24 635.2
1951 4 54.38 723.8
1952 4 71.78 864.1
1953 4 90.08 1193.5
1954 4 68.6 1188.9
1950 5 418.8 1677.4
1951 5 588.2 2289.5
1952 5 645.2 2159.4
1953 5 641 2031.3
1954 5 459.3 2115.5
Time dimension
Cross section dimension
What is panel data?
1950 1 642.9 3755.6
1951 1 755.9 4833
1952 1 891.2 4924.9
1953 1 1304.4 6241.7
1954 1 1486.7 5593.6
1950 2 100.66 693.5
1951 2 160.62 809
1952 2 145 727
1953 2 174.93 1001.5
1954 2 172.49 703.2
1950 3 93.5 1610.5
1951 3 135.2 1819.4
1952 3 157.3 2079.7
1953 3 179.5 2371.6
1954 3 189.6 2759.9
1950 4 32.24 635.2
1951 4 54.38 723.8
1952 4 71.78 864.1
1953 4 90.08 1193.5
1954 4 68.6 1188.9
1950 5 418.8 1677.4
1951 5 588.2 2289.5
1952 5 645.2 2159.4
1953 5 641 2031.3
1954 5 459.3 2115.5
What is panel data?
Data for many individuals (cross sections)
across time
Previous slides show the data in stacked
format.
What is the relationship between
investment and value of the
firm?
Plot Investment and
value as a scatter
plot.
Data is stacked which
implies that this is the
relationship across
time and across firms
0
1000
2000
3000
4000
5000
6000
7000
0 200 400 600 8001000 1400
Investment
V
a
l
u
e
firm?
The relationship is
positive.
Is this the case for
each firm in our
panel?
0
1000
2000
3000
4000
5000
6000
7000
8000
0 200 400 600 8001000 1400
Investment
V
a
l
u
e
firm?
2500
3000
3500
4000
4500
5000
5500
6000
6500
200 400 600 800 1000 1200 1400 1600
Investment
V
a
l
u
e
1
400
500
600
700
800
900
1000
1100
20 40 60 80 100 120 140 160 180
Investment
V
a
l
u
e
2
1000
1500
2000
2500
3000
0 40 80 120 160 200
Investment
V
a
l
u
e
3
0
200
400
600
800
1000
1200
1400
10 20 30 40 50 60 70 80 90 100
Investment
V
a
l
u
e
4
1200
1400
1600
1800
2000
2200
2400
2600
2800
200 300 400 500 600 700
Investment
V
a
l
u
e
5
Positive
slope
But different
Starting points
Panel data methods
Most of panel data analysis is concerned
with measuring these two aspects of panel
data relationships:
I
i,t
o
i
[V
i,t
c
i,t
Slope
Intercept
i=15 denotes firms
T=1950
is time
Panel data methods
Usually assume that slope is the same across
cross sections
The intercept can be different. In this lecture we
will talk about three ways of modelling these
differences
(a) Pooled OLS
(b) Fixed Effects (Within estimator)
(c) Between estimator
(c) Random Effects
Pooled OLS
Model:
To estimate:
Step 1: Stack data
Step 2: Apply OLS formula
I
i,t
o [V
i,t
c
i,t
Same intercept
Step1
Year Firm Investment Value of the firm Constant
1950 1 642.9 3755.6 1
1951 1 755.9 4833 1
1952 1 891.2 4924.9 1
1953 1 1304.4 6241.7 1
1954 1 1486.7 5593.6 1
Step 1
1950 1 642.9 3755.6 1
1951 1 755.9 4833 1
1952 1 891.2 4924.9 1
1953 1 1304.4 6241.7 1
1954 1 1486.7 5593.6 1
1950 2 100.66 693.5 1
1951 2 160.62 809 1
1952 2 145 727 1
1953 2 174.93 1001.5 1
1954 2 172.49 703.2 1
Data for firms on top of one another
Step 1
1950 1 642.9 3755.6 1
1951 1 755.9 4833 1
1952 1 891.2 4924.9 1
1953 1 1304.4 6241.7 1
1954 1 1486.7 5593.6 1
1950 2 100.66 693.5 1
1951 2 160.62 809 1
1952 2 145 727 1
1953 2 174.93 1001.5 1
1954 2 172.49 703.2 1
1950 3 93.5 1610.5 1
1951 3 135.2 1819.4 1
1952 3 157.3 2079.7 1
1953 3 179.5 2371.6 1
1954 3 189.6 2759.9 1
1950 4 32.24 635.2 1
1951 4 54.38 723.8 1
1952 4 71.78 864.1 1
1953 4 90.08 1193.5 1
1954 4 68.6 1188.9 1
1950 5 418.8 1677.4 1
1951 5 588.2 2289.5 1
1952 5 645.2 2159.4 1
1953 5 641 2031.3 1
1954 5 459.3 2115.5 1
Y variable
X
variables
Step 2
Apply OLS formula
[
,o
X
1
X
Y
Y I
i,t
X V
i,t
,constant
Fixed Effects
Model
To estimate
(a) Stack data
(b) Use OLS formula
I
i,t
o
i
[V
i,t
c
i,t
Different intercept for each firm
Step 1: the data
Year Firm Investment Value of the firm Constant for firm 1 Constant for firm2 Constant for firm 3 Constant for firm 4 Constant for firm 5
1950 1 642.9 3755.6 1 0 0 0 0
1951 1 755.9 4833 1 0 0 0 0
1952 1 891.2 4924.9 1 0 0 0 0
1953 1 1304.4 6241.7 1 0 0 0 0
1954 1 1486.7 5593.6 1 0 0 0 0
1950 2 100.66 693.5 0 1 0 0 0
1951 2 160.62 809 0 1 0 0 0
1952 2 145 727 0 1 0 0 0
1953 2 174.93 1001.5 0 1 0 0 0
1954 2 172.49 703.2 0 1 0 0 0
1950 3 93.5 1610.5 0 0 1 0 0
1951 3 135.2 1819.4 0 0 1 0 0
1952 3 157.3 2079.7 0 0 1 0 0
1953 3 179.5 2371.6 0 0 1 0 0
1954 3 189.6 2759.9 0 0 1 0 0
1950 4 32.24 635.2 0 0 0 1 0
1951 4 54.38 723.8 0 0 0 1 0
1952 4 71.78 864.1 0 0 0 1 0
1953 4 90.08 1193.5 0 0 0 1 0
1954 4 68.6 1188.9 0 0 0 1 0
1950 5 418.8 1677.4 0 0 0 0 1
1951 5 588.2 2289.5 0 0 0 0 1
1952 5 645.2 2159.4 0 0 0 0 1
1953 5 641 2031.3 0 0 0 0 1
1954 5 459.3 2115.5 0 0 0 0 1
Y variable
X variables
Dummy for each firm
Step 2: Use OLS formula
I
i,t
o
i
[V
i,t
c
i,t
[
,o
1
,o
2
,o
3
,o
4
,o
5
X
X
1
X
Y
Y I
i,t
X V
i,t
,5dummies
We get estimates of the (common) slope
And estimates of the constant for each firm. These are
Referred to as fixed effects or individual effects
This estimation is equivalent
to..
(a) Transforming each variable by subtracting the cross-sectional
mean
(b) Use OLS formula on this de-meaned data. This is used
when the number of cross sections is very large
(c) Note that this is called the within transformation and
the resulting estimator is called the within estimator
(d) Uses only variation through time of each unit, not
between units
Y I
i,t

i
X V
i,t
V
i
Transformation?
Year Firm Investment Cross Section Mean of Investmen

1950 1 642.9 1016.22
1951 1 755.9 1016.22
1952 1 891.2 1016.22
1953 1 1304.4 1016.22
1954 1 1486.7 1016.22
1950 2 100.66 150.74
1951 2 160.62 150.74
1952 2 145 150.74
1953 2 174.93 150.74
1954 2 172.49 150.74
1950 3 93.5 151.02
1951 3 135.2 151.02
1952 3 157.3 151.02
1953 3 179.5 151.02
1954 3 189.6 151.02
1950 4 32.24 63.416
1951 4 54.38 63.416
1952 4 71.78 63.416
1953 4 90.08 63.416
1954 4 68.6 63.416
1950 5 418.8 550.5
1951 5 588.2 550.5
1952 5 645.2 550.5
1953 5 641 550.5
1954 5 459.3 550.5
Mean
For firm i across
time
Before transformation
-3 -2 -1 0 1 2 3
0
20
40
60
80
100
Y
X
Firm 1
-1 0 1 2 3 4 5
0
20
40
60
80
100
Y
X
Firm 2
-1 0 1 2 3 4
0
20
40
60
80
100
Y
X
Firm 3
-4 -3 -2 -1 0 1 2 3
0
20
40
60
80
100
Y
X
Firm 4
Same
slope
Different
Intercepts!
After transformation
-4 -3 -2 -1 0 1 2 3
0
20
40
60
80
100
Y
X
Firm 1
-3 -2 -1 0 1 2 3
0
20
40
60
80
100
Y
X
Firm 2
0 1 2 3 4 5 6
0
20
40
60
80
100
Y
X
Firm 3
-2 -1 0 1 2 3 4
0
20
40
60
80
100
Y
X
Firm 4
Same
intercepts
Between estimator
The fixed effects estimator uses
information on variation through time
The between estimator uses only
information across cross-sections
OLS regression on averages i.e.
Y
i
X V
i
Generalised Least Squares
Note that for any heteroskedastic model:
Estimation by GLS exploits the fact that:
V E
X y
2
] [

=
+ =
I VV V
V V E E
X y
V X V y V
2 2 / 1 2 / 1 2
2 / 1 2 / 1 * *
* * *
2 / 1 2 / 1 2 / 1

] [ ] ' [

= =

=
+ =
+ =

Square
root
of
covariance
matrix
Random Effects
Model:
Variation across cross sections is random
I
i,t
o [V
i,t
c
i,t
j
i
Unit specific shock
Ec
i,t
0,Ej
i
0
Ec
i,t
2
o
c
2
,Ej
i
2
o
j
2
Ec
i,t
,j
j
0 Ej
i
,j
j
0
Random Effects
Lets consider the ith cross-section
The covariance matrix of w is
I
t
o [V
t
c
t
j
i
W
t
c
t
j
i
EW
t
2
o
c
2
o
j
2
EW
t
W
s
o
j
2
,t s
Random Effects
introduces a particular (heteroscedastic)
structure
+
+
+
=
2 2 2 2
2 2 2 2
2 2 2 2
u u u
u u u
u u u

L
M O M M
L
L
VARW
t
Random Effects
Covariance matrix block diagonal
=
= I
L
M O M M
L
L
0 0
0 0
0 0
Estimation
As with FE, estimation is carried out by
(a) transforming the variables to remove the
covariance structure.
(b) Using OLS on the transformed variables
This is an example of generalised least
squares
Estimation
We need
This is a function of
GLS is equivalent to the following
transformation of Y and X
2 / 1 2 / 1
] [

= I
o
c
2
,o
j
2
1/2
Y
it

1
o
c
Y
it
0 Y
i
0 1
o
c
To
u
2
oc
2
If this is equal to zero
FE and RE the same
Estimation
We need estimates of
Consider
And
Deviations removes heterogeneity
o
c
,o
j
I
it
o [V
it
c
it
j
i
i
o [V
i
c
i
j
i
I
it

i
[V
it
V
i
c
it
c
Estimation
So FE can be used to estimate
Consider the between regression
o
c
e
i

i
o [V
i
c
i
j
i
vare
i

o
c
2
T
o
j
2
o
j
2
vare
i

o
c
2
T
Fixed or Random
Type of dataset
Hausman test. Tests the assumptions
needed for random effects to be consistent
If null hypothesis is rejected use fixed
effects
Ec
i,t
,j
j
0
Hausman test
Call the FE estimator with estimated
covariance matrix ; and the RE estimator
with
If the RE model is correct, is consistent and
efficient, and so >
If the RE model is wrong, then the RE estimates
are inconsistent, but the FE estimates are still
consistent
The Hausman test uses the test statistic:
F
(
F
V
)
(
R
V
) ( ~ )

( )]
( )
( [ )

(
2 1
k V V
R F R F R F

(
F
V
)
(
R
V
Pooled OLS?
Can test to see if fixed effects are
significant and should be included.
Pooled estimator not appropriate if fixed
effects important
Dynamic Panel data
Model
Lets estimate using FE
This is because the average contains
I
i,t
o
i
[V
i,t
I
i,t1
c
i,t
I
i,t

i
[V
i,t
V
i
I
i,t1

t1,i
c
i,t
c
Correlated !
Implies inconsistency
c
it
c
it1
Anderson Hsiao IV estimator
Step 1: Take first differences
Step 2: use instruments for the RHS
variables
Valid instruments include
Level instruments generally preferred
I
i,t
I
i,t1
[V
i,t
V
i,t1
I
i,t1
I
i,t2
c
i,t
c
i,t1
Z
it
I
i,t2
,I
i,t2
[
Z
it
Z
it
1
Z
it
I
it
Anderson Hsiao
Consistent estimator, but does not exploit all
moment conditions
In period 3 our equation is:
Instruments
In period 4
Instruments and so on
I
i,3
I
i,2
[V
i,3
V
i,2
I
i,2
I
i,1
c
i,3
c
i,2
V
i,1
,I
i,1
I
i,4
I
i,3
[V
i,4
V
i,3
I
i,3
I
i,2
c
i,4
c
i,3
V
i,2
,I
i,2
,V
i,1
,I
i,1
Arrelano and Bond Estimator
AB propose using these extra moment
conditions
W
Z
i1
Z
i1
,Z
i2
.
.
Z
i1
,Z
i2
...Z
it2
EW
c
it
c
i
0
Arrelano and Bond Estimator
One and two step estimator
Second step standard errors biased
downwards so inference based on first
step
[
1step
X
it
WV
0
1
W
X
it
1
X
it
WV
0
1
W
I
it
Preliminary estimate of weighting matrix

2step
X
it
WV
1
1
W
X
it
1
X
it
WV
1
1
W
I
it
[
Based on residuals from the first step
Valid Instruments
Test for second order serial correlation for
validity of GMM
Sargan test
Ec
it
c
it2
0
2
1
1
~ ) ( ) )( ( '
K p
asy
i
N
i
i i i
W W W s

=
Second step residuals
Number of columns of W
Panel Time Series
Panels with long T readily available.
Raises some special issues for panel data
analysis.
Heterogeneity
Heterogeneous panels
y
it
o
i
B
i
x
i,t

i
y
it1
v
t
Change across
Cross-sections
B
i
B p
i
i
t
i
y
it
o
i
Bx
it
y
it1
e
t
e
t
p
i
x
it
t
i
y
it1
v
it
If homogeneity assumed
Serially correlated error term
Fixed effects and GMM biased and
inconsistent as they impose slope
homogeneity
A valid model is the mean group model
Estimate
B
Estimate
y
1t
o
1
B
1
x
1,t

1
y
1t1
v
1t
y
2t
o
2
B
2
x
2,t

2
y
2t1
v
2t
.
.
y
Nt
o
N
B
N
x
N,t

N
y
Nt1
v
Nt
o
1
N

o
i
B
1
N

B
i

1
N

i
Means
Panel unit root tests
Levin and Lin (1992) and Levin Lin and Chu
(2002). Model is:
Test
The equation can be augmented to account
for serial correlation
Assume that all series have the same under
the alternative hypothesis
y
it
o
i
t
t
y
it1
c
i
t v
it
H0 : 0vs H0 : 0
Instead, Im, Pesaran and Shin (1992-
2003) Model is:
Test
based on the average T-ratio across i
Maddala and Wu 1999 suggest the test
statistic
y
it
o
i
t
t

i
y
it1
c
i
t v
it
H0 :
i
0vs H0 :
i
0
2
i1
N
lnp
i
~_
2
2N
P-value for ith ADF regression
Panel Unit Root tests
These unit root tests assume cross
sections are uncorrelated.
Pesaran (2007) proposes the following
modification to the IPS test
y
it
o
i
t
t
y
it1
[y
t1
c
i
t v
it
Average across cross sections
Proxy for common component
Interpretation can be difficult
If the null hypothesis is rejected it does not
mean that all series are stationary
It may simply mean some of the series in
the panel are stationary
Panel data in Eviews
Organising data
Date and
id
Panel data in Eviews: Importing
data
Panel data in Eviews: reshaping
data
Re-shaping data into a panel
Re-shaping data into a panel
Estimation
Once this is done standard equation
commands apply.
Goto->quickestimate equation to
estimate model

1 An Introduction To Panel Data Methods

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1 An Introduction To Panel Data Methods

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The Bank of England does not accept any liability for misleading or inaccurate information or omissions in the information

Year Firm Investment Cross Section Mean of Investmen

Preliminary estimate of weighting matrix

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