The Covariance Transformation and the Instrumental Variables Estimator of the Fixed Effects Model

The Jerome Levy Economics Institute Working Paper No. 28

13 Pages Posted: 26 Oct 1999

See all articles by Jeffrey L. Pliskin

Jeffrey L. Pliskin

Hamilton College; The Levy Economics Institute

Date Written: July 1989

Abstract

The covariance transformation is a useful and often necessary procedure to estimate the fixed effects model. When some explanatory variables are contemporaneously correlated with the disturbance term, the covariance transformation can be used in conjunction with an instrumental variables procedure to obtain a consistent estimator. This paper describes how to correctly compute the IV estimator as a two stage least squares estimator. In addition, I show that if the IV estimator is incorrectly computed using a two stage least squares approach where the covariance transformation is not applied until the second stage, the resulting estimator is not in general consistent.

JEL Classification: C23, C33

Suggested Citation

Pliskin, Jeffrey L., The Covariance Transformation and the Instrumental Variables Estimator of the Fixed Effects Model (July 1989). The Jerome Levy Economics Institute Working Paper No. 28, Available at SSRN: https://ssrn.com/abstract=181091 or http://dx.doi.org/10.2139/ssrn.181091

Jeffrey L. Pliskin (Contact Author)

Hamilton College ( email )

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The Levy Economics Institute

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