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Re: st: Cross-Sectional Time Series

From   anirban basu <>
Subject   Re: st: Cross-Sectional Time Series
Date   Tue, 25 Jun 2002 11:52:40 -0500 (CDT)

Hi John,

With reg command and cluster option, one basically imposes an exchangeable
correlation structure on the data. i.e assume corr (y(i), y(j)) = rho,
where i ne j and  i,j are any two observation from the same cluster. Rho
is constant for every pair of observation within a cluster. So, one can
visuaize it in terms of a random effects model where :

Y(k) = Xb + U(k) + e, where k represents clusters and U(k) is a
cluster-specific random effect that is common to all observation in that
cluster. However, -reg- does not give estimates of this random effect. It
just estimates -betas- assuming this structure.

However, this estimation is correct only if U(k) are uncorrelated with
Xs. i.e. the unobserved characteristics of a cluster over time is
uncorrelated with the X over time. If not then fixed effects is useful.

With fixed effects, one evades the correlation problem by taking
differences. i.e for any cluster k:

Y(ik) - Y(1k) = [X(ik) - X(1k)]b + [e(ik) - e(1k)]

Note that by taking the difference, the unobserved U(k) is eliminated.
However, fixed effects assume the U(k) is fixed over time for any cluster
k. i.e. the unobserved characteristics of a cluster is not changing over
time. Also, since we are taking a difference, fixed effects model cannot
estimate the betas for baseline covariates since they cancel out in the

Hope this helps,


Doctoral Student
Harris School of Public Policy Studies
University of Chicago
(312) 563 0907 (H)

On Tue, 25 Jun 2002, John Neumann wrote:

> Hello all,
> Since I frequently see panel data questions flying around the
> list, I'm thinking that some of you can provide me with a
> very succinct answer to the following question, and in so
> doing clarify conceptually for me the data-related issue:
> I have data on investment products, by year.  Not all
> products have data in each year.  The dependent
> variable is scaled in such a way as to make time series
> variation in its levels of no concern.  Here's the question:
> What is the difference between using the reg command,
> with the robust and cluster option, vs. the xtreg command
> fixed effects model?  The cluster variable using reg would
> naturally be the i( ) parameter for xtreg ...
> Thanks!
> John Neumann
> Boston University
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