Tatiana Mikhailova

Econometrics-II 2021

Home assignment 4
Due 10:00 April, 20 2021

Vectors are in bold, scalars are in plain text.

1. Consider a standard xed eects model for panel data:

yit = xit β + ci + uit ,

where Cov(ci , xit ) 6= 0, uit are iid with E[uit |xi,1 ...xiT , ci ] = 0, V ar(uit ) = σ 2 .
a) To obtain a xed eects (within) estimator β̂F E we rst apply a xed-eect
transformation. Calculate the autocorrelation coecient for the transformed errors
Corr[üit , üi,t−1 ], where üit = uit − ūi .
b) To obtain a rst-dierence estimator β̂F D we rst apply a rst-dierence transformation.
Calculate the autocorrelation coecient for the transformed errors Corr[∆uit , ∆ui,t−1 ],
where ∆uit = uit − ui,t−1 .

Now suppose the errors in the original model were autoregressive, i.e.

uit = ρui,t−1 + eit ,

where E[ui,0 |xi,1 ...xiT , ci ] = E[eit |xi,1 ...xiT , ci ] = 0, eit are iid, ui,0 is independent of all the
other random variables, V ar(ui,0 ) = 1−ρ σ2
2 , V ar(eit ) = σ ?
2

c) How would your answer to a) and b) change?

d) True or false? Explain, why. "If there is persistence in the original errors, it's better to
use rst-dierence method, but if the errors are independent, xed eects estimator is
preferable."

2. (WA, problem 11.14) Use the data in ezunem.dta. Consider a model for unemployment claims
in a city i in a year t:
ln(uclmsit ) = θt + ci + git t + δ1 ezit + uit ,
where ezit is an indicator that an enterprise zone regime was in operation.1
1 Russian equivalent is "Osobaya ekonomicheskaya zona a territory with the special tax regime that provides tax
credits and subsidies to rms that invest into the territory.

1
a) Apply a rst-dierence transformation and estimate the transformed model via xed
eects. What is the estimated eect of the enterprize zones?
b) Now let the enterprize zones aect not only level, but also the growth of unemployment
claims.
ln(uclmsit ) = θt + ci + git t + δ1 ezit + δ2 ezit t + uit
Reestimate the model.
c) Reestimate the model setting δ1 = 0. Does this model t better than the one from a)?
d) Let wi be an unobserved time-constant variable, and suppose we add β1 wi + β2 wi t to the
random growth model. Can either β1 or β2 be estimated? Explain.