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Re: st: RE: Controlling for year in panel data

From   "Clive Nicholas" <[email protected]>
To   [email protected]
Subject   Re: st: RE: Controlling for year in panel data
Date   Thu, 28 Jul 2005 04:15:02 +0100 (BST)

Glenn Hoetker wrote:

> I have panel data from 1986-2003.  Logic and examining the data suggest
> that the dependent variable increased monotonically over time. Because I
> have some time-invariant variables, I am using random-effects (Hausman
> test indicates this is okay). What are the relative merits of either:
> a. Including a YEAR variable, which will range from 1985 to 2003 in
> value, or
> b. Including 7 dummies, one for each year (except the omitted year)
> Possibly complicating the issue (or not), I have two dummy variables,
> one of which is set to one for all observations after 1994 and the other
> set to one after 1998.  I have 47 observations per year, so degrees of
> freedom are not critical.
> I have found little guidance in my standard texts. Thank you for any
> guidance &/or references.

Adding to Austin's (correct) comments, I think the issue of whether you
should have one time trend variable or several time dummies is very much a
trade-off, but I would strongly favour time dummies if the conditions are

The best argument for having a _time-trend_ is that it's a much more
parsimonious indicator of temporal effects: if Y = gpdgrowth and X1 =
-0.252*time (p<.05), we can see at a stroke that as time progresses,
economic growth significantly declines. The trouble is, of course, that
this can be too crude an indicator: what if growth declined four times but
rose three times in our period of observation?

That, of course, is where _time dummies_ come in. With these, we can
perhaps model such idiosyncratic temporal effects much more intelligently.
The trouble here - as Glenn insinuated - is that if degrees of freedom are
at a premium, we may be forced to use a time-trend instead.

If DF is _not_ a problem, however, I would use time-dummies every time.
Certainly, anytime I have fitted fixed-effect models to my own data, I
have always found time dummies to be more satisfactory in explaining the
underlying dynamics of the model than using time-trends: the difference in
model-fit is often overwhelming. Moreover, I've often noticed changes in
sign, as well drastic shifts in significance, to the other variables when
fitting models using either approach.

I hope this helps.

CLIVE NICHOLAS        |t: 0(044)7903 397793
Politics              |e: [email protected]
Newcastle University  |

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