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Faculty of Economics

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Jochmans, K. and Otsu, T.

Likelihood Corrections for Two-way Models

Annals of Economics and Statistics

no. 134 pp. 227-242 (2019)

Abstract: The use of panel data models with two-way fixed effects is widespread. Incidental-parameter bias, however, invalidates inference based on the (profile) likelihood. We consider modifications to the likelihood that yield asymptotically-unbiased estimators as well as test statistics that are size correct under rectangular-array asymptotics. The modifications are widely applicable and easy to implement. Through several examples we illustrate that the modifications can lead to dramatic improvements relative to maximum likelihood, both in terms of point estimation and inference.

Keywords: Fixed Effects, Information Bias, Modified Profile Likelihood, Panel Data, Penalization, Rectangular-Array Asymptotics

JEL Codes: C33

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Cambridge Working Paper in Economics Version of Paper: Likelihood Corrections for Two-way Models, Jochmans, K., Otsu, T., (2018)

Cambridge Working Paper in Economics Version of Paper: Testing for Correlation in Error-Component Models, Jochmans, K., (2019)

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