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Improved Inference for Interactive Fixed Effects Model under Cross-Sectional Dependence

Author

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  • Zhenhao Gong

    (Shanxi University of Finance and Economics)

  • Min Seong Kim

    (University of Connecticut)

Abstract

This paper proposes an inference procedure for the interactive fixed effects model that is valid in the presence of cross-sectional dependence. When the error terms are cross-sectionally dependent, the Least Square (LS) estimator of this model is asymptotically biased and therefore the associated confidence interval tends to have a large coverage error. To address this, we propose a bias correction of the LS estimator and a cross-sectional dependence robust variance estimator to construct associated test statistics. The paper also discusses practical issues in implementing the proposed method, including the construction of distance that reflects the decaying pattern of cross-sectional dependence and the selection of the bandwidth parameters. Monte Carlo simulations show our procedure works well in finite samples. As empirical illustrations, we apply our procedure to study the effect of divorce law reforms on divorce rates and the impact of clean water and sewerage interventions on child mortality.

Suggested Citation

  • Zhenhao Gong & Min Seong Kim, 2024. "Improved Inference for Interactive Fixed Effects Model under Cross-Sectional Dependence," Working papers 2024-02, University of Connecticut, Department of Economics.
    • Handle: RePEc:uct:uconnp:2024-02
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    References listed on IDEAS

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    More about this item

    Keywords

    Bandwidth selection; Bias correction; Robust inference; Spatial HAC method;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • J12 - Labor and Demographic Economics - - Demographic Economics - - - Marriage; Marital Dissolution; Family Structure
    • I18 - Health, Education, and Welfare - - Health - - - Government Policy; Regulation; Public Health

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