Panel data

Panel data is a combination of cross section and time series data. This implies that it contains time series observations of the number of individuals (cross sectional units). It can be represented as Yit = b1 + b2X2it + b3X3it + Uit Where i shows the cross section dimension whereas t shows the time series dimension. Panel data can be balanced or unbalanced. A balanced panel data is one in which each cross sectional unit has the same number of time series observations. Otherwise the panel data is an unbalanced panel data. Estimation of panel data (1) Pooled regression In this case the slope coefficients and intercepts do not vary over time and cross section and the error term captures the differences over time and cross section. This is just a stacking of cross section units for all the time periods i.e. usual OLS.

(2) Slope coefficients are constant but intercept varies across cross section units Fixed effects or Least squares dummy variables (LSDV) In this case, the individual characteristics of each cross sectional unit are represented by the intercept term. However, the intercept terms are time invariant i.e. it does not vary with time. And the slope coefficients do not vary with time and cross section. The individual characteristics of each cross section unit can also be denoted by the dummy variables for the cross section units. Dummies can also be used to depict the time effect in the regression. FE model can be estimated through de-meaning method.

(3) Slope coefficients constant and intercept varies over time and cross section. This can be done through including cross section and time dummies as differential intercept dummies.

(4) All coefficients i.e. slope coefficients and intercept vary across cross section units.

This is proceeded through introducing differential intercept dummies and differential slope dummies or interactive dummies.

(5) Random effects approach Using the fixed effects model for the estimation is expensive in terms of degrees of freedom lost through use of dummies for either the time effect or the cross sectional effects. Also, in the FE models, we do not include relevant explanatory variables that do not change over time and include dummy variables to represent such variables. Therefore, it does not represent a true model. Instead of using dummy variables, we can include the differences in the cross sectional units in the form of the error term. This is called random effects approach. Yit = B1 + B2X2it + B3X3it + ei + uit Here, B1 is the common mean value for the intercept ei represents the individual differences in the intercept values of each cross sectional unit. RE model can be estimated through Generalized Least Squares (GLS) method. Difference between the FE model and the RE model in the FE model, each cross section has fixed intercept term whereas in the RE model, there is a common mean value of an intercept and the error term (ei) represents the deviation of each cross section from the mean value of the intercept. In FE model, error term is not correlated with the explanatory variables whereas in the RE model, error term is uncorrelated with the explanatory variables. Seemingly Unrelated Regression (SUR) SUR consists of several linear regressions with different dependent variables with their own set of independent variables. The error terms of these regressions are correlated. Advantages of panel data (1) As panel data is a combination of the time series and the cross section data, it is more informative. It has more degrees of freedom and lesser multicollinearity a compared to simple cross section or time series model. (2) It considers cross section specific characteristics thereby taking the heterogeneity into account. (3) By including dynamic relationships and information of cross section specific characteristics, panel data controls for omitted variable bias.

Disadvantages of panel data (1) Panel data modeling is a difficult and a complex process.

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