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re: RE: RE: st: Robust Standard Errors in Paneldatasets

From   Christopher F Baum <[email protected]>
To   <[email protected]>
Subject   re: RE: RE: st: Robust Standard Errors in Paneldatasets
Date   Tue, 26 Oct 2010 15:14:01 -0400

Amy wrote 

Petersen wrote (p. 458):

One way empirical finance researchers can address two sources of correlation
is to parametrically estimate one of the dimensions (e.g., by including dummy
variables). Since many panel data sets have more firms than years, a common
approach is to include dummy variables for each time period (to absorb the time
effect) and then cluster by firm (Lamont and Polk, 2001; Anderson and Reeb,
2004; Gross and Souleles, 2004; Sapienza, 2004; and Faulkender and Petersen,
2006). If the time effect is fixed (e.g., Equation (15)), the time dummies completely
remove the correlation between observations in the same time period.
In this case, there is only a firm effect left in the data. As seen in Section 1,
OLS and Fama-MacBeth standard errors are biased in this case, while standard
errors clustered by firm are unbiased (results available from the author).

Stas pointed out that clustered SEs are never unbiased. Point well taken. I would not suggest they are.

The above statement by Petersen makes no sense to me. Compare the contemporaneous correlations ("correlation between observations in the same time period")
for a one-way FE, two-way FE and the strange creature he suggests: one-way FE with time dummies, clustered by firm.* In all three cases the contemporaneous
correlations are quite similar. The contemporaneous correlation cannot be removed by including time dummies.

This should not be surprising, for correlation within a firm's observations is not removed by including firm dummies (fixed effects); you need to use the 
cluster VCE to allow for such correlations (and as Stock/Watson have shown, that is mandatory unless you assume iid errors). So why would you expect 
that allowing intercepts to shift for each time period would have the effect of removing correlations across firms for each time period? I'm sorry, but that
quote from a published article is just plain wrong.

* do          to see this demonstrated.


Kit Baum   |   Boston College Economics and DIW Berlin   |
An Introduction to Stata Programming   |
An Introduction to Modern Econometrics Using Stata   |

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