Chapter 5: Model Building, Panel Method

 The situation often arises in financial modelling

where we have data comprising both time series and
cross-sectional elements, and such a dataset would
be known as a panel of data or longitudinal data.
 A panel of data will embody information across both
time and space.
 Importantly, a panel keeps the same individuals or
objects (henceforth we will call these ‘entities’) and
measures some quantity about them over time.
 Econometrically, the setup we may have is as
described in the following equation:
 Panel data allows you to control for variables
you cannot observe or measure like cultural
factors or difference in business practices
across companies; or variables that change
over time but not across entities (i.e. National
policies, country regulations, international
agreements, etc.).
 Thus, it accounts for individual heterogeneity
 If each cross-sectional unit has the same
number of time series observations, then such
a panel (data) is called a balanced panel.
 WHY PANEL DATA
 Since panel data relate to individuals, firms, states,
countries, etc., over time, there is bound to be
heterogeneity in these units. The techniques of panel
data estimation can take such heterogeneity explicitly
into account.
 By combining time series of cross-section observations,
panel data give more informative data, more variability,
less collinearity among variables, more degrees of
freedom and more efficiency.
 By studying the repeated cross section of observations,
panel data are better suited to study the dynamics of
change e.g spells of unemployment, job turnover, and
labour mobility are better studied with panel data.
 By making data available for several thousand units,
panel data can minimize the bias that might result if
we aggregate individuals or firms into broad
aggregates.
 Panel data can better detect and measure effects that
simply cannot be observed in pure cross-section or
pure time series data.
 For example, the effects of minimum wage laws on
employment and earnings can be better studied if
we include successive waves of minimum wage
increases in the country or state minimum wages
 Two methods used are namely Fixed Effect and
Random Effect
 WHICH MODEL SHOULD WE USE?
 The selection of a computational model
should be based on our expectation about
whether or not the studies share a common
effect size and on our goals in performing the
analysis.
 THE FIXED EFFECTS APPROACH
 It makes sense to use the fixed-effect model if
two conditions are met.
 First, we believe that all the studies included
in the analysis are functionally identical.
 A fixed effects model is a statistical model that
represents the observed quantities in terms of
explanatory variables that are treated as if the
quantities were non-random..
 The fixed effect of this variable is the average
effect in the entire population of organisations,
expressed by the regression coefficient.
 In the fixed-effect analysis we assume that the true
effect size is the same in all studies, and the
summary effect is our estimate of this common
effect size.
 Under the fixed-effect model we assume that the
true effect size for all studies is identical, and the
only reason the effect size varies between studies is
sampling error (error in estimating the effect size).
 Therefore, when assigning weights to the different
studies we can largely ignore the information in
the smaller studies since we have better
information about the same effect size in the
larger studies.
 Example
 Suppose that a pharmaceutical company will use a thousand
patients to compare a drug versus placebo. Because the staff
can work with only 100 patients at a time, the company will
run a series of ten trials with 100 patients in each.
 The studies are identical in the sense that any variables
which can have an impact on the outcome are the same
across the ten studies.
 Specifically, the studies draw patients from a common pool,
using the same researchers, dose, measure, and so on (we
assume that there is no concern about practice effects for
the researchers, nor for the different starting times of the
various cohorts).
 All the studies are expected to share a common effect and
so the first condition is met.
 The goal of the analysis is to see if the drug
works in the population from which the
patients were drawn (and not to extrapolate
to other populations), and so the second
condition is met, as well.
 In this example the fixed-effect model is a
plausible fit for the data and meets the goal
of the researchers.
 Random Effects
 In the random-effects analysis we assume that the
true effect size varies from one study to the next,
and that the studies in our analysis represent a
random sample of effect sizes that could have
been observed.
 Under the random-effects model the goal is not to
estimate one true effect, but to estimate the
mean of a distribution of effects.
 Since each study provides information about a
different effect size, we want to be sure that all
these effect sizes are represented in the summary
estimate.
 When the researcher wishes to investigate
differences between organisations in the
effect of job level on work satisfaction, it will
be necessary to specify also a random effect
of this variable, meaning that it is assumed
that the effect varies randomly within the
population of organisations, and the
researcher is interested to test and estimate
the variance of these random effects across
this population.
 Such an effect is also called a random slope.
 CONCLUDING REMARKS
 Differences between the fixed-model and the
random-effects model focused largely on the
computation of a summary effect and the
confidence intervals for the summary effect.
 Fixed-effect meta-analysis estimates a single
effect that is assumed to be common to every
study, while a random-effects meta-analysis
estimates the mean of a distribution of
effects.
 Practical Example

Recently MFIs in developing countries have been confronted

with various challenges that have affected their scope of
operations; key concerns have been the lack of donor support
(Rao, 2011) and competition from commercial banks that are
providing microfinance due to potential profitability in
microfinance business. These developments have forced most
MFIs to focus their attention on financial sustainability and
efficiency for them to remain operational. The Institutionalists’
view towards finance is a departure from traditional
approaches of reaching to the poor of the poorest.
Theoretically, the question which needs to be answered is
whether shifting focus towards sustainability and efficiency
reduces the mandate of MFIs to reach to the poor. Welfarists
and Institutionalists have not reached a consensus on whether
sustainability and outreach can be jointly attained. To
contribute to this debate, this study analyses implications of
 Research Questions and Hypothesis

The specific objectives of the study are as

follows:
1. To estimate financial sustainability and
outreach of MFIs in Harare;
2. To examine determinants of financial
sustainability of MFIs in Harare
3. To analyse the potential compatibility
between sustainability and outreach of MFIs
Regression Models
 Specific Models
Financial Sustainability Model

Outreach Models
Three measures of outreach to the poor used were average
loan size, percentage of women and the number of active
borrowers.
 Stata Commands
Entering Data from a Spreadsheet

1. Type Edit on the command window

2. Save the Workfile using File Save AS into a
specific folder
3. You open the File by clicking on File and then
Open.
4. After using the Workfile you can using clear
to clear up the screen
 GENERATE NATURAL LOGS OF VARIABLES
• ge lnborrowersfs= ln(borrowersfs)
• ge lnmfisizefs=ln(mfisizefs)
• ge lncostpborfs=ln(costpborfs)
• ge lnavoutloanfs=ln(avoutloanfs)
• ge lnstcostpdolfs=ln(stcostpdolfs)
• ge lninstalgrfs=ln(instalgrfs)
• ge lnt2matindfs=ln(t2matindfs)
• ge lnt2matgrfs=ln(t2matgrfs)
• ge lnborrpstafffs=ln(borrpstafffs)
• ge Inoeratiofs=ln(oeratiofs)
• ge lnavdisloanfs=ln(avdisbloanfs)
 Fixed Effect and Random Effect

Commands
Before using xtreg set stata to handle panel data by
using . xtset sn year
. xtset sn year
panel variable: sn (strongly balanced)
time variable: year, 2011 to 2013
delta: 1 unit
 DESCRIPTIVE SUMMARY OF VARIABLES

. summarize fss capstrucfs intratefs lnstcostpdolfs lncostpborfs lnavoutloanfs

lnmfisizefs femalefs yieldfs lnborrowersfs parfs minloanindifs

Variable Obs Mean Std. Dev. Min Max

fssit 102 2.058431 1.400033 -.92 9

capstrucfs 102 .6001961 .2223456 .02 1
intratefs 102 .1233333 .0450046 .06 .155
lnstcostpd~s 102 -2.973923 .4768597 -4.60517 -2.302585
lncostpborfs 102 3.643473 .9856749 1.515127 5.978506

lnavoutloa~s 102 5.13537 1.325294 1.297463 9.505422

lnmfisizefs 102 14.26246 1.409027 11.01847 17.01772
femalefs 102 .3435294 .2487579 0 1
yieldfs 102 .1509804 .1734764 -.37 .77
lnborrower~s 102 7.23541 1.119258 4.997212 11.52008

parfs 102 .0841176 .0800167 0 .39

minloanind~s 102 245.9706 732.7023 1.83 6716.18
Presentations as follows:
 The mean (FSS) is 2.058. Compared to the recommended minimum
threshold of 100 percent, the results indicate that MFIs in Harare are
financially sustainable.
 The capital structure measures the ratio of equity to total assets of the
MFI, the higher the ratio the more sustainable the MFI. The mean capital
structure for the MFIs is financed by 60 percent of equity
 The interest rate charge by MFIs in Harare averages 12.33 percent per
year. The rate of interest charged my MFIs on the outstanding loans
determines the profitability
 The average cost per borrower is approximately USD 364. This is very
important because it determines the cost of maintaining one client. The
lower the cost, the more efficient the MFI in reducing costs of maintain
the borrowers. Other countries its 72.
 The outreach of MFIs is achieved by targeting the most vulnerable such as
women and/or people with very low incomes. Female clients account for
an average of around 34.4 percent while male clients are 63.6 percent.
The percentage of female borrowers is low as compared to male
borrowers; therefore, the MFIs in Harare are not targeting the most
vulnerable groups in Harare. They are granting loans to wealthy clients
thus ensuring sustainability.
 Choosing Fixed or Random Effect - Hausman Test
 To run a Hausman test comparing fixed with random
effects in Stata, you need to first estimate the fixed
effects model, save the coefficients so that you can
compare them with the results of the next model,
estimate the random effects model, and then do the
comparison.
 The hausman test tests the null hypothesis that the
coefficients estimated by the efficient random effects
estimator are the same as the ones estimated by the
consistent fixed effects estimator. If they are
(insignificant P-value, Prob>chi2 larger than .05) then
it is safe to use random effects. If you get a significant
P-value less than 0.05, you should use fixed effects.
 Fixed Effect
• xtreg fss capstrucfs intratefs lnstcostpdolfs lncostpborfs lnavoutloanfs
lnmfisizefs femalefs yieldfs lnborrowersfs parfs minloanindifs, fe
Fixed-effects (within) regression Number of obs = 102
Group variable: sn Number of groups = 34

R-sq: within = 0.3387 Obs per group: min = 3

between = 0.0633 avg = 3.0
overall = 0.0151 max = 3

F(11,57) = 2.65
corr(u_i, Xb) = -0.9842 Prob > F = 0.0081

fssit Coef. Std. Err. t P>|t| [95% Conf. Interval]

capstrucfs .3687504 .6759591 0.55 0.588 -.9848344 1.722335

intratefs -2.71551 5.853345 -0.46 0.644 -14.43663 9.005611
lnstcostpdolfs -1.284431 .3638793 -3.53 0.001 -2.013087 -.5557757
lncostpborfs -.0012753 .1717319 -0.01 0.994 -.3451625 .3426119
lnavoutloanfs .1083143 .1509589 0.72 0.476 -.1939758 .4106043
lnmfisizefs 4.252025 6.467221 0.66 0.514 -8.698362 17.20241
femalefs 1.328148 .5704279 2.33 0.023 .1858862 2.470411
yieldfs -.7525492 .810355 -0.93 0.357 -2.375257 .8701586
lnborrowersfs -.083389 .1686257 -0.49 0.623 -.4210563 .2542782
parfs -.7067325 1.751796 -0.40 0.688 -4.214644 2.801179
minloanindifs .0000841 .0002391 0.35 0.726 -.0003946 .0005629
_cons -62.54423 90.75662 -0.69 0.494 -244.2812 119.1928

sigma_u 6.2795375
sigma_e 1.1280158
rho .96874047 (fraction of variance due to u_i)

F test that all u_i=0: F(33, 57) = 1.98 Prob > F = 0.0117

• estimates store fixed

 Random Effect
• xtreg fss capstrucfs intratefs lnstcostpdolfs lncostpborfs lnavoutloanfs
lnmfisizefs femalefs yieldfs lnborrowersfs parfs minloanindifs, re
Random-effects GLS regression Number of obs = 102
Group variable: sn Number of groups = 34

R-sq: within = 0.3258 Obs per group: min = 3

between = 0.0944 avg = 3.0
overall = 0.2097 max = 3

Wald chi2(11) = 30.95

corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0011

fssit Coef. Std. Err. z P>|z| [95% Conf. Interval]

capstrucfs .3837332 .6009443 0.64 0.523 -.794096 1.561562

intratefs .1882235 2.853021 0.07 0.947 -5.403595 5.780042
lnstcostpdolfs -1.143774 .2971892 -3.85 0.000 -1.726254 -.561294
lncostpborfs -.0165477 .1461913 -0.11 0.910 -.3030774 .2699821
lnavoutloanfs .0335005 .1294756 0.26 0.796 -.2202671 .2872681
lnmfisizefs -.0869277 .1297634 -0.67 0.503 -.3412592 .1674039
femalefs 1.308753 .5008787 2.61 0.009 .3270485 2.290457
yieldfs -.3661208 .715604 -0.51 0.609 -1.768679 1.036437
lnborrowersfs -.0916663 .1386156 -0.66 0.508 -.3633478 .1800152
parfs -.7365432 1.558885 -0.47 0.637 -3.791902 2.318816
minloanindifs .0000972 .0002082 0.47 0.641 -.0003109 .0005053
_cons -.1615644 2.271928 -0.07 0.943 -4.614461 4.291332

sigma_u .74039641
sigma_e 1.1280158
rho .30110122 (fraction of variance due to u_i)

. estimates store random

 Compare Fixed and Random
hausman fixed random
Coefficients
(b) (B) (b-B) sqrt(diag(V_b-V_B))
fixed random Difference S.E.

capstrucfs .3687504 .3837332 -.0149828 .3094942

intratefs -2.71551 .1882235 -2.903733 5.11096
lnstcostpd~s -1.284431 -1.143774 -.1406574 .2099685
lncostpborfs -.0012753 -.0165477 .0152724 .0901107
lnavoutloa~s .1083143 .0335005 .0748138 .0776187
lnmfisizefs 4.252025 -.0869277 4.338953 6.465919
femalefs 1.328148 1.308753 .0193957 .2729626
yieldfs -.7525492 -.3661208 -.3864283 .3802448
lnborrower~s -.083389 -.0916663 .0082772 .0960227
parfs -.7067325 -.7365432 .0298107 .7991665
minloanind~s .0000841 .0000972 -.0000131 .0001175

b = consistent under Ho and Ha; obtained from xtreg

B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(10) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 5.15
Prob>chi2 = 0.8810
 Hypothesis Testing
 H0: Effects are Random
 H1: Effects are fixed

Decision Rule

If Prob>chi2 > .05

Do not Reject the null hypothesis (Therefore
the Effects are Random)
 Heteroscedasticity Test
• regress fss capstrucfs intratefs lnstcostpdolfs lncostpborfs lnavoutloanfs
lnmfisizefs femalefs yieldfs lnborrowersfs parfs minloanindifs

Source SS df MS Number of obs = 102

F( 11, 90) = 2.23
Model 42.3999046 11 3.85453678 Prob > F = 0.0192
Residual 155.569444 90 1.72854938 R-squared = 0.2142
Adj R-squared = 0.1181
Total 197.969349 101 1.96009256 Root MSE = 1.3147

fssit Coef. Std. Err. t P>|t| [95% Conf. Interval]

capstrucfs .4128935 .6541662 0.63 0.530 -.8867219 1.712509

intratefs -.0163534 3.292861 -0.00 0.996 -6.558197 6.52549
lnstcostpdolfs -.9823669 .3121549 -3.15 0.002 -1.602517 -.3622167
lncostpborfs -.0355778 .1554228 -0.23 0.819 -.3443524 .2731968
lnavoutloanfs -.0138094 .1369681 -0.10 0.920 -.2859204 .2583016
lnmfisizefs -.0672213 .1086272 -0.62 0.538 -.2830281 .1485855
femalefs 1.201054 .5379228 2.23 0.028 .1323761 2.269731
yieldfs -.0933675 .7824149 -0.12 0.905 -1.647771 1.461036
lnborrowersfs -.1329426 .1507853 -0.88 0.380 -.4325039 .1666187
parfs -.4917685 1.696194 -0.29 0.773 -3.861553 2.878016
minloanindifs .0001266 .0002229 0.57 0.571 -.0003162 .0005694
_cons .6240413 2.067229 0.30 0.763 -3.48287 4.730953
 • estat hettest
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity
Ho: Constant variance
Variables: fitted values of fssit

chi2(1) = 58.10
Prob > chi2 = 0.0000
 Since prob>chi2 is < 0.05 we therefore reject the null
hypothesis that variance is constant. This model should be
estimated using Robust
 Testing Serial Correlation
 pwcorr fss capstrucfs intratefs lnstcostpdolfs lncostpborfs
lnavoutloanfs lnmfisizefs femalefs yieldfs lnborrowersfs parfs
minloanindifs, sig
fssit capstr~s intrat~s lnstco~s lncost~s lnavou~s lnmfis~s

fssit 1.0000

capstrucfs 0.1262 1.0000

0.2062

intratefs -0.0644 -0.3678 1.0000

0.5202 0.0001

lnstcostpd~s -0.3753 -0.1459 0.1439 1.0000

0.0001 0.1435 0.1492

lncostpborfs -0.1475 0.1171 -0.1095 0.3659 1.0000

0.1391 0.2412 0.2733 0.0002

lnavoutloa~s -0.0905 -0.0059 -0.0610 0.0693 0.2318 1.0000

0.3654 0.9531 0.5424 0.4891 0.0190

lnmfisizefs -0.1750 -0.0010 0.0246 0.1476 0.2018 0.3571 1.0000

0.0785 0.9918 0.8061 0.1388 0.0419 0.0002

femalefs 0.2127 0.0767 0.0655 0.0237 0.0046 -0.0445 -0.0969

0.0318 0.4436 0.5129 0.8129 0.9631 0.6573 0.3326

yieldfs 0.0355 -0.0445 0.0630 -0.0533 -0.0104 0.1123 -0.0450

0.7235 0.6572 0.5290 0.5948 0.9177 0.2613 0.6532

lnborrower~s -0.1938 -0.0432 0.1464 0.1968 0.0202 0.4720 0.4497

more
 Since correlation of all variables are less than
0.8, it means serial correlation does not exist
among variables.
 Testing Multicollinearity
 Type vif
Variable VIF 1/VIF

lnavoutloa~s 1.93 0.519394

lnborrower~s 1.66 0.600872
minloanind~s 1.56 0.641694
lncostpborfs 1.37 0.729228
lnmfisizefs 1.37 0.730542
lnstcostpd~s 1.29 0.772394
intratefs 1.28 0.779292
capstrucfs 1.24 0.808960
yieldfs 1.08 0.928977
parfs 1.08 0.929069
femalefs 1.05 0.955800

Mean VIF 1.35

 Since the vif for all varibales are less than 10, there is no
problem of multicollinearity.
 Run Regression with Robust
• xtreg fss capstrucfs intratefs lnstcostpdolfs lncostpborfs lnavoutloanfs
lnmfisizefs femalefs yieldfs lnborrowersfs parfs minloanindifs, re
vce(robust)

Random-effects GLS regression Number of obs = 102

Group variable: sn Number of groups = 34

R-sq: within = 0.3258 Obs per group: min = 3

between = 0.0944 avg = 3.0
overall = 0.2097 max = 3

Wald chi2(11) = 44.56

corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000

(Std. Err. adjusted for 34 clusters in sn)

Robust
fssit Coef. Std. Err. z P>|z| [95% Conf. Interval]

capstrucfs .3837332 .4915388 0.78 0.435 -.5796652 1.347132

intratefs .1882235 3.357147 0.06 0.955 -6.391664 6.768111
lnstcostpdolfs -1.143774 .4473142 -2.56 0.011 -2.020494 -.2670543
lncostpborfs -.0165477 .1212083 -0.14 0.891 -.2541116 .2210163
lnavoutloanfs .0335005 .149286 0.22 0.822 -.2590946 .3260956
lnmfisizefs -.0869277 .107074 -0.81 0.417 -.2967888 .1229335
femalefs 1.308753 .6163301 2.12 0.034 .1007678 2.516738
yieldfs -.3661208 .7408199 -0.49 0.621 -1.818101 1.085859
lnborrowersfs -.0916663 .1024214 -0.89 0.371 -.2924086 .1090761
parfs -.7365432 1.452304 -0.51 0.612 -3.583006 2.10992
minloanindifs .0000972 .0001189 0.82 0.413 -.0001357 .0003301
_cons -.1615644 2.54649 -0.06 0.949 -5.152594 4.829465

sigma_u .74039641
sigma_e 1.1280158
rho .30110122 (fraction of variance due to u_i)
Regression Results