Lecture 24
Supplement
(Chapter 16)
Copyright © 2006 Pearson Addison-Wesley. All rights reserved.
Example: Production Functions
• Note: the French firm panel is “balanced.”
• A balanced panel includes observations for
every firm in every time period.
• An unbalanced panel would include firms
that entered or exited the data in the middle
of the period.
• For example, a firm might exit the data
because it went out of business.
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24S-2
Example: Production Functions (cont.)
• Some data sets are naturally balanced.
• Some researchers choose to balance their
panels artificially by discarding firms that are
not present in every time period.
• This procedure is inefficient: it discards
useful data.
• Much worse, artificially balancing panels can
introduce severe biases.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved.
24S-3
Example: Production Functions (cont.)
• Firms that are more productive (for
unobserved reasons) are more likely to
stay in business.
• Such firms also tend to enjoy higher marginal
benefits from capital, so they choose to invest
in higher capital levels.
• Unobserved productivity leads to omitted
variables bias.
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24S-4
Example: Production Functions (cont.)
• When we artificially balance a panel, we
select firms that are particularly productive
(and that tend to have higher capital levels).
• This sample selection bias can greatly
exacerbate the omitted variables bias,
depending on how much entry and exit is
occurring during the period.
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24S-5
Example: Production Functions (cont.)
• Olley and Pakes (Econometrica 1996)
examined US telecommunications equipment
manufacturers from 1974–1987.
• In this period there was a great deal of
entry and exit.
• The balanced panel has 896 observations.
• The unbalanced panel has 2,592
observations.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved.
24S-6
Example: Production Functions (cont.)
• Olley and Pakes compare the estimated
coefficient on capital when they:
1. Use fixed effects on a balanced panel,
2. Use FE on the full dataset, and
3. Use advanced techniques to estimate the
unobserved productivity and control for it.
• Balanced Panel FE: 0.067
• Full Data FE:
0.150
• No-OVB:
0.339 to 0.355
Copyright © 2006 Pearson Addison-Wesley. All rights reserved.
24S-7
Example: Production Functions (cont.)
• The balanced panel creates a large bias.
• Simply moving from a balanced panel to an
unbalanced panel doubles the estimated
capital coefficient.
• However, unobserved productivity that
varies over time (and is thus not controlled by
fixed effects) continue to bias the estimate in
this sample.
• Eliminating OVB doubles the estimate.
Copyright © 2006 Pearson Addison-Wesley. All rights reserved.
24S-8