Modified first-difference estimator in a panel data model with unobservable factors both in the errors and the regressors when the time dimension is small

ABSTRACT

Panel data models with factor structures in both the errors and the regressors have received considerable attention recently. In these models, the errors and the regressors are correlated and the standard estimators are inconsistent. This paper shows that, for such models, a modified first-difference estimator (in which the time and the cross-sectional dimensions are interchanged) is consistent as the cross-sectional dimension grows but the time dimension is small. Although the estimator has a non standard asymptotic distribution, t and F tests have standard asymptotic distribution under the null hypothesis.

KEYWORDS:

• Common shocks
• factors
• panel data

MATHEMATICS SUBJECT CLASSIFICATION:

• 91G70

Funding

This research was partially supported by Australian Research Council grant DP0985432.