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On the Fixed-Effects Vector Decomposition

Published online by Cambridge University Press:  04 January 2017

Trevor Breusch ,
Michael B. Ward ,
Hoa Thi Minh Nguyen  and
Tom Kompas
Trevor Breusch*
Affiliation:
Crawford School of Economics and Government, The Australian National University, Canberra, ACT 0200, Australia
Michael B. Ward
Affiliation:
Crawford School of Economics and Government, The Australian National University, Canberra, ACT 0200, Australia e-mail: michael.ward@anu.edu.au
Hoa Thi Minh Nguyen
Affiliation:
Crawford School of Economics and Government, The Australian National University, Canberra, ACT 0200, Australia e-mail: hoa.nguyen@anu.edu.au
Tom Kompas
Affiliation:
Crawford School of Economics and Government, The Australian National University, Canberra, ACT 0200, Australia e-mail: tom.kompas@anu.edu.au
*
e-mail: trevor.breusch@anu.edu.au (corresponding author)
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Abstract

This paper analyzes the properties of the fixed-effects vector decomposition estimator, an emerging and popular technique for estimating time-invariant variables in panel data models with group 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 three-stage 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 that finds: (1) The estimator reproduces exactly classical fixed-effects estimates for time-varying variables. (2) The standard errors recommended for this estimator are too small for both time-varying and time-invariant variables. (3) The estimator is inconsistent when the time-invariant variables are endogenous. (4) The reported sampling properties in the original Monte Carlo evidence do not account for presence of a group effect. (5) The decomposition estimator has higher risk than existing shrinkage approaches, unless the endogeneity problem is known to be small or no relevant instruments exist.

Information

Type
Symposium on Fixed-Effects Vector Decomposition
Information
Political Analysis , Volume 19 , Issue 2 , Spring 2011 , pp. 123 - 134
Copyright
Copyright © The Author 2011. Published by Oxford University Press on behalf of the Society for Political Methodology 

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Footnotes

Authors' note: Supplementary materials for this article are available on the Political Analysis Web site.

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Supplementary material: File

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Data 1

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Data 2

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Table 1

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Table 2

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