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Linear regression for panel with unknown number of factors as interactive fixed effects

Authors: Hyungsik Roger Roger Moon and Martin Weidner
Date: 29 July 2015
Type: Journal Article, Econometrica, Vol. 83, No. 4, pp. 1543--1579
DOI: 10.3982/ECTA9382

Abstract

In this paper, we study the least squares (LS) estimator in a linear panel regression model withunknown number of factors appearing as interactive fixed effects. Assuming that the number of factors used in estimation is larger than the true number of factors in the data, we establish the limiting distribution of the LS estimator for the regression coefficients as the number of time periods and the number of cross-sectional units jointly go to infinity. The main result of the paper is that under certain assumptions, the limiting distribution of the LS estimator is independent of the number of factors used in the estimation as long as this number is not underestimated. The important practical implication of this result is that for inference on the regression coefficients, one does not necessarily need to estimate the number of interactive fixed effects consistently.

Previous version:
Hyungsik Roger Roger Moon and Martin Weidner August 2014, Linear regression for panel with unknown number of factors as interactive fixed effects, cemmap Working Paper, CWP35/14, Cemmap

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