3
$\begingroup$

Is subtracting individuals means during pre-processing of panel data exactly equivalent to including dummy variables for fixed effects estimation? If not, what are the differences, and is there some literature dealing with this?

$\endgroup$

1 Answer 1

4
$\begingroup$

When you subtract the individual means $$y_{it} - \overline{y}_{i} = (X_{it} - \overline{X}_i)\beta + \epsilon_{it} - \overline{\epsilon}_i$$ where $\overline{y}_{i} = \frac{1}{T}\sum^{T}_{t=1}y_{it}$, $\overline{x}_{i} = \frac{1}{T}\sum^{T}_{t=1}x_{it}$, and $\overline{\epsilon}_{i} = \frac{1}{T}\sum^{T}_{t=1}\epsilon_{it}$, and then run an OLS regression with the de-meaned variables then this is the fixed effects estimator. This is equivalent to including individual dummies in the regression which was shown by Mundlak (1978).

$\endgroup$
1
  • $\begingroup$ What if one of your independent variables is categorical? Then you must generate dummy variables? $\endgroup$ Nov 4, 2023 at 16:52

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.