Chapter 15

Panel Data Models

Walter R. Paczkowski
Rutgers University
Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 1
 Worked Example
Hill et al Chapter 15, Question 10

Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 2
 (a) (i) If deterrence increases crime rates should drop.
(ii) If wages in the private sector increase the return to
legal activities increases relative to
the return to illegal activities. Therefore crime rates
should drop.
(iii) Higher population density is linked with a higher
residential crime rate.
(iv) Young males are the most likely demographic
group to be involved in illegal
activities. Thus, an increase in the percentage of young
males should increase the
crime rate.
Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 3
 (b) The estimated equation is EQ01

(i) LPRBARR, LPRBCONV, LPRBPRIS and LAVGSEN are explanatory

variables that describe the deterrence effect of the legal system. We
expect the coefficients of these variables to be negative. We find that all
of these coefficients are negative except for the coefficient of
LPRBPRIS. The variable LWMFG, which represents wages in the
private sector, has a positive coefficient that is not consistent with our
expectations.
All coefficients are significantly different from zero at a 5% level of
significance except for the coefficient of LAVGSEN.

(ii) Since the model is in log-log form, all coefficients are elasticities.
The coefficient of LPRBARR suggests that a 1% increase in the
probability of being arrested results in a
0.66% decrease in the crime rate.
Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 4
 (c) The estimated equation is: EQ02

The reported intercept term is the average of the fixed effects.

(i) All estimated coefficients have the expected sign except
for LAVGSEN. Moreover, all estimated coefficients are
significantly different from zero at a 5% level of significance
except for the coefficient for LAVGSEN.
(ii) The coefficient on LPRBARR suggests that a 1% increase
in the probability of being arrested results in a 0.23%
decrease in the crime rate. This estimated elasticity is less
than half of the estimated elasticity from part (b). Thus, once
we allow for county heterogeneity, the deterrent effect of
being arrested is much less.

Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 5
 (c) (iii) The coefficient on LAVGSEN suggests that
a 1% increase in the average prison sentence
results in a 0.0183% increase in the crime rate.
However, a two tail t-test on the significance this
estimate yields a t-statistic of 0.5906 and a p-value
of 0.555. Thus, a null hypothesis that the
coefficient of LAVGSEN is zero is not rejected.
There is no support for the idea that longer prison
sentences are a deterrent to crime.

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 (d) To test H0: all intercepts are equal against the
alternative that not all of the intercepts are equal, we
use the usual F-test for testing a set of linear
restrictions. The calculated value is
F = 33.749, while the 5% critical value of
F(0.95, 89, 535) = 1.287. Thus, we reject H0 and
conclude that the county level effects are not all zero.
[To test for the presence of individual differences
go to View/Fixed/Random Effects
Testing/Redundant Fixed Effects—Likelihood Ratio.
A significant F implies that the intercept coefficients are
different  there is heterogeneity]
Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 7
 (e) EQ03
(i) It is apparent that the coefficient estimates
obtained by using least squares are very different
to those obtained using the fixed effects method.
The magnitudes change considerably and there are
some sign reversals. Ignoring county effects can
lead to misleading conclusions.

Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 8
 (e) (ii) The outcome of the test for the joint significance of the dummy variables is
different for each of the two models. In the least squares estimated model with no fixed
effects the F and p values for the test are 1.324 and 0.2442, respectively, leading us to
conclude that there is no evidence of time effects. On the other hand, in the fixed effects
model, the F and p values for the test are 9.118 and 0.0000, respectively,leading us to
conclude that there are time effects.

Since we have established the importance of the county effects, and this importance is
confirmed if we carry out a further test for their inclusion in the model with time effects,
our final conclusion is that the least squares test result is misleading and the year effects
are important. An examination of the coefficients for the year dummies in the fixed
effects model does show some evidence of a trend effect. The coefficients for 1982, 1983
and 1984 are all small and not significantly different from zero, and so there does not
appear to be a trend effect in these early years. However, from a small increase in 1985,
there are dramatic increases in the coefficients for 1986 and 1987, suggesting an upward
trend in the crime rate.

Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 9
 (iii) The coefficient of LWMFG represents the
elasticity of the crime rate with respect to the
average weekly wage in the manufacturing sector.
The least squares estimation suggests that a 1%
increase the average weekly wage in the
manufacturing sector results in a 0.0160%
increase in the crime rate, although this estimate is
not significantly different from zero. The fixed
effects estimation suggests that a 1% increase in
average weekly wage will result in a 0.5762%
decrease in the crime rate.

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 (f) According to the fixed effects estimates, the
explanatory variables which have the expected signs and
a significant effect on the crime rate are LPRBARR,
LPRBCONV, LPRBPRIS, LWMFG, LEDNSITY and
LPCTYMLE. Out of these variables, those that have the
largest effect on crime rate, and are reasonable to
implement as public policy, will be the most effective in
dealing with crime. Improving policing and court policies
that increase the probability of arrest, conviction and
imprisonment are likely to be effective, but lengthening
the term of imprisonment is not. Opportunities for higher
wages and the avoidance of high-density population areas
are also likely to be productive directions for public
policy.
Principles of Econometrics, 4th Edition Chapter 15: Panel Data Models Page 11