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Untangling Fixed Effects and Constant Regressors

Author

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  • Rutger Teulings

    (University of Amsterdam)

  • Franc Klaassen

    (University of Amsterdam)

Abstract

Fixed effects (FE) in panel data models overlap each other and prohibit the identification of the impact of ``constant'' regressors. Think of regressors that are constant across countries in a country-time panel with time FE. The traditional approach is to drop some FE and constant regressors by normalizing their impact to zero, such that the remaining parameters can be estimated. We introduce ``untangling normalization'', meaning that we orthogonalize the FE and, if present, the constant regressors. The untangled FE are much easier to interpret, because they do no longer overlap but are now in deviations with respect to each other. Moreover, the impact of constant regressors can now be estimated, and the untangled FE indicate to what extent the estimates reflect the true value. Our untangled estimates are a linear transformation of the traditional, zero-normalized estimates; no new estimation is needed. We apply the approach to a gravity model for OECD countries' exports to the US. The constant regressors US GDP, world GDP, and the US effective exchange rate explain 90% of the time FE. We use an F-test to show that the time FE are redundant, so the estimated impacts of the constant regressors indeed reflect the true value.

Suggested Citation

  • Rutger Teulings & Franc Klaassen, 2016. "Untangling Fixed Effects and Constant Regressors," Proceedings of International Academic Conferences 4106394, International Institute of Social and Economic Sciences.
    • Handle: RePEc:sek:iacpro:4106394
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    Cited by:

    1. Rutger Teulings, 2017. "Brexit and The Impact of Gradual Economic Integration on Export," Tinbergen Institute Discussion Papers 17-075/VI, Tinbergen Institute.
    2. repec:spo:wpmain:info:hdl:2441/4v3ds3it5k8isrrec0qlf7bt4m is not listed on IDEAS
    3. Caselli, Mauro & Schiavo, Stefano & Nesta, Lionel, 2018. "Markups and markdowns," Economics Letters, Elsevier, vol. 173(C), pages 104-107.
    4. Soederhuizen, Beau & van Heuvelen, Gerrit Hugo & Luginbuhl, Rob & Stiphout-Kramer, Bert van, 2023. "Optimal capital ratios for banks in the euro area," Journal of Financial Stability, Elsevier, vol. 69(C).
    5. repec:hal:spmain:info:hdl:2441/4v3ds3it5k8isrrec0qlf7bt4m is not listed on IDEAS
    6. Beau Soederhuizen & Bert van Stiphout-Kramer & Harro van Heuvelen & Rob Luginbuhl, 2021. "Optimal capital ratios for banks in the euro area," CPB Discussion Paper 429, CPB Netherlands Bureau for Economic Policy Analysis.
    7. Franc Klaassen & Rutger Teulings, 2017. "Untangling Real Gravity," Tinbergen Institute Discussion Papers 17-121/VI, Tinbergen Institute.

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    More about this item

    Keywords

    gravity model; fixed effects; multicollinearity; normalization; orthogonalization;
    All these keywords.

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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