== Fixed and Random Effects ==

IX. Fixed Effects.

A. Unmodeled Heterogeneity. We hope that our independent
variables have explained much of what is different about an
observation, a unit, or a year, but there is probably some unmodeled
heterogeneity. Since we havent modeled it, it goes into ei,t. The real
problem comes when some units (or, less commonly, time periods)
share some unmodeled heterogeneity. Wed love to be able to explain
everything that makes Luxembourg different, but usually we cant, so
we need to violate the prohibition on using proper names as
independent variables and do something to remove this shared and
thus systematic heterogeneity from the error term.
B. The Fixed Effects Model in Concept. One way to do this
is to estimate a fixed effects model that gives Luxembourg and
every other unit in our study its own intercept. The most intuitive way
to do this would be by including a dummy variable for N-1 units. We
still assume that the betas pool across units, so in essence we have N
parallel regression lines. Observations across time in each unit vary
around a baseline level specific that unit. Note that any substantive
explanatory variables that do not vary across time in each unit will be
perfectly collinear with the fixed effects, and so we cannot include
them in the model (or estimate their effects).
yi,t = i + xi,t + ei,t
C. Sketch of a Test for Fixed Effects. The null hypothesis is
that our simple, restrictive model was appropriate, that all of the units
share the same intercept. The alternative is that they vary across
units, so the way to test this is by running both models and then
comparing their sum of squares in a joint F-test.
D. Estimating the Fixed Effects Model. We could just
include dummy variables for all but one of the units. If we have panel
data, though, this sacrifices a lot of degrees of freedom. And with so
many units and very few time periods, these intercepts may be picking
up on a lot of random error and thus be quite inconsistent. Were not
going to learn much of substance from these incidental or
nuisance parameters. So this frees us to estimate the effect of our
substantive coefficients in a slightly different way that preserves the
substantive story of fixed effects without costing us so many degrees
of freedom. We convert our xs and y for each observation into a

deviation from the mean in that unit. This sweeps out the unit
effects because when you mean deviate variables, you no longer need
to include an intercept term. So the model regresses yi,t mean(yi) on
xi,t mean(xi). This is often called this within estimator because it
looks at how changes in the explanatory variables cause y to vary
around a mean within the unit. Stata has a canned procedure that (I
believe) transforms your variables in this way and then corrects the
standard errors to reflect the fact that N of your observations bring no
new information (since they are determined by the mean and the
other observations for each unit).
xtreg DiscretionarySpending salary totalday staffper init ideo leg_dd gov_dem
docs_g senc_g medi_g noreast, fe
Fixed-effects (within) regression
Group variable (i): alpha

Number of obs
Number of groups

=
=

616
44

R-sq:

Obs per group: min =

avg =
max =

14
14.0
14

within = 0.0126
between = 0.0232
overall = 0.0053

corr(u_i, Xb)

= -0.3025

F(3,569)
Prob > F

=
=

2.42
0.0648

-----------------------------------------------------------------------------Discretion~g |
Coef.
Std. Err.
t
P>|t|
[95% Conf. Interval]
-------------+---------------------------------------------------------------salary | -2.94e-06
5.26e+07
-0.00
1.000
-1.03e+08
1.03e+08
totalday | (dropped)
staffper | (dropped)
init | (dropped)
ideol | (dropped)
leg_dd | -.1616329
.0701156
-2.31
0.022
-.29935
-.0239159
gov_dem | -.0682768
.0426327
-1.60
0.110
-.1520135
.0154599
docs_g | (dropped)
senc_g | (dropped)
medi_g | (dropped)
noreast | (dropped)
_cons |
4.374255
1.33e+12
0.00
1.000
-2.62e+12
2.62e+12
-------------+---------------------------------------------------------------sigma_u | .51059043
sigma_e | .42354445
rho | .59238137
(fraction of variance due to u_i)
-----------------------------------------------------------------------------F test that all u_i=0:
F(43, 569) =
7.86
Prob > F = 0.0000

X. Random Effects
A. The Random Effects Model in Concept. Instead of
thinking of each unit as having its own systematic baseline, we think
of each intercept as the result of a random deviation from some mean
intercept. The intercept is a draw from some distribution for each
unit, and it is independent of the error for a particular observation.
Instead of trying to estimate N parameters as in fixed effects, we just
need to estimate parameters describing the distribution from which

each units intercept is drawn. If we have a large N (panel data), we

will be able to do this, and random effects will be more efficient than
fixed effects. It has N more degrees of freedom, and it also uses
information from the between estimator (which averages
observations over a unit and regresses average y on average x to look
at differences across units). Another nice property is that you can still
have explanatory variables that dont change over time for a unit. If
we have a big T (TS-CS data), then the difference between fixed
effects and random effects goes away.
yi,t = + i + xi,t + ei,t
B. Sketch of a Test for Random Effects. A small assumption
is that Cov(i , ei) = 0. A huge assumption is that Cov(i , xi) = 0,
which means that the things that make a units intercept different are
unrelated to the countrys xs. In concept, a test regresses the errors
on the xs.
C. Estimating the Random Effects Model.
xtreg DiscretionarySpending salary totalday staffper init ideo leg_dd gov_dem
docs_g senc_g medi_g noreast, re
Random-effects GLS regression
Group variable (i): alpha

Number of obs
Number of groups

=
=

616
44

R-sq:

Obs per group: min =

avg =
max =

14
14.0
14

within = 0.0125
between = 0.5560
overall = 0.3272

Random effects u_i ~ Gaussian

corr(u_i, X)
= 0 (assumed)

Wald chi2(11)
Prob > chi2

=
=

53.09
0.0000

-----------------------------------------------------------------------------Discretion~g |
Coef.
Std. Err.
z
P>|z|
[95% Conf. Interval]
-------------+---------------------------------------------------------------salary |
8.34e-06
5.39e-06
1.55
0.122
-2.23e-06
.0000189
totalday |
.0000968
.0008137
0.12
0.905
-.0014979
.0016916
staffper | -.0223183
.0209193
-1.07
0.286
-.0633193
.0186828
init | -.2080793
.1182186
-1.76
0.078
-.4397836
.0236249
ideol |
.6509317
.8078395
0.81
0.420
-.9324047
2.234268
leg_dd | -.1153163
.064981
-1.77
0.076
-.2426768
.0120442
gov_dem | -.0570731
.042057
-1.36
0.175
-.1395033
.0253572
docs_g |
.0700836
.0764945
0.92
0.360
-.0798429
.2200101
senc_g |
.056224
.1389907
0.40
0.686
-.2161928
.3286409
medi_g |
.1813995
.0828276
2.19
0.029
.0190605
.3437385
noreast |
.4777465
.126015
3.79
0.000
.2307616
.7247314
_cons |
3.74571
.2060277
18.18
0.000
3.341903
4.149517
-------------+---------------------------------------------------------------sigma_u | .32985269
sigma_e | .42354445
rho | .37753489
(fraction of variance due to u_i)
------------------------------------------------------------------------------