Chapter 14
1. Which of the following assumptions is required for obtaining unbiased fixed effect estimators?
a. The errors are heteroskedastic.
b. The errors are serially correlated.
c. The explanatory variables are strictly exogenous.
d. The unobserved effect is correlated with the explanatory variables.
2. A pooled OLS estimator that is based on the time-demeaned variables is called the _____.
a. random effects estimator
b. fixed effects estimator
c. least absolute deviations estimator
d. instrumental variable estimator
3. What should be the degrees of freedom (df) for fixed effects estimation if the data set includes ‘N’
cross sectional units over ‘T’ time periods and the regression model has ‘k’ independent variables?
a. N-kT
b. NT-k
c. NT-N-k
d. N-T-k
4. Which of the following types of variables cannot be included in a fixed effects model?
a. Dummy variable
b. Discrete dependent variable
c. Time-varying independent variable
d. Time-constant independent variable
5. Which of the following is a property of dummy variable regression?
a. This method is best suited for panel data sets with many cross-sectional observations.
b. The R-squared obtained from this method is lower than that obtained from regression on time-
demeaned data.
c. The degrees of freedom cannot be computed directly with this method.
d. The major statistics obtained from this method are identical to that obtained from regression on
time-demeaned data.
6. Which of the following is a difference between a fixed effects estimator and a first-difference
estimator?
a. The fixed effects estimators are always larger than the first difference estimators in a two-period
panel data analysis.
b. The fixed effects estimator is more efficient than the first-difference estimator when the idiosyncratic
errors are serially uncorrelated.
c. The first difference estimator is more sensitive to nonnormality and heteroskedasticity.
d. The bias in the first difference estimator depends on the time period (T) of analysis while the bias in
the fixed effect does not depend on T.
7. Which of the following assumptions is required for obtaining unbiased random effect estimators?
a. The idiosyncratic errors are heteroskedastic.
b. The unobserved effect is independent of all explanatory variables in all time periods.
c. The idiosyncratic errors are serially correlated.
d. The unobserved effect is correlated with the explanatory variables.
8. The estimator obtained through regression on quasi-demeaned data is called the _____.
a. random effects estimator
b. fixed effects estimator
c. hetroskedasticity-robust OLS estimator
d. instrumental variables estimator
9. The random effects approach _____.
a. cannot be used if the key explanatory variable is constant over time.
b. is preferred to pooled OLS because RE is generally more efficient.
c. is suitable if the Hausman test rejects the assumption that the unobserved effect is uncorrelated with
the explanatory variables.
d. is more convincing than fixed effects for policy analysis using aggregate data.
10. The random effects estimate is identical to the fixed effects estimate if the estimated transformation
parameter , θ
̂, in generalized least squares estimation that eliminates serial correlation between error
terms is, _____.
a. less than zero
b. equal to zero
c. equal to one
d. greater than one
11. Which of the following is true of the correlated random effects approach (CRE)?
a. The CRE approach assumes that the unobserved effect is uncorrelated with the observed explanatory
variables.
b. The CRE approach cannot be used if the regression model includes a time-constant explanatory
variable.
c. The CRE approach considers that the unobserved effect is correlated with the average level of
explanatory variables.
d. The CRE estimate equals the random effects estimate.
12. Which of the following is a reason for using the correlated random effects approach?
a. It provides unbiased and consistent estimators when the idiosyncratic errors are serially correlated.
b. It provides unbiased and consistent estimators when the idiosyncratic errors are heteroskedastic.
c. It provides a more efficient estimate than the fixed effects approach.
d. It provides a way to include time-constant explanatory variables in a fixed effects analysis.
13. In the correlated random effects approach, the regression model includes _____.
a. time averages as separate explanatory variables
b. at least one dummy variable
c. more than one endogenous explanatory variable
d. an instrumental variable
14. An economist wants to study the effect of income on savings. He collected data on 120 identical
twins. Which of the following methods of estimation is the most suitable method, if income is correlated
with the unobserved family effect?
a. Random effects estimation
b. Fixed effects estimation
c. Ordinary least squares estimation
d. Weighted Least squares estimation
15. Which of the following statements is true?
a. Fixed effects estimation is not suitable when the unobserved cluster effect is correlated with one or
more explanatory variables.
b. Fixed effects approach is not applicable if the key explanatory variables change only at the level of the
cluster.
c. The ordinary least squares standard errors are incorrect when there is cluster effect.
d. Random effects estimation can be applied to a cluster sample only if the unobserved cluster effect is
correlated with one or more explanatory variables.
16. A data set is called an unbalanced panel if it has missing years for at least some cross-sectional units
in the sample.
17. In a random effects model, we assume that the unobserved effect is correlated with each
explanatory variable.
18. The value of the estimated transformation parameter in generalized least square estimation that
eliminates serial correlation in error terms indicates whether the estimates are likely to be closer to the
pooled OLS or the fixed effects estimates.
19. The correlated random effects approach cannot be applied to models with many time-varying
explanatory variables.
20. Pooled ordinary least squares estimation is commonly applied to cluster samples when eliminating a
cluster effect via fixed effects is infeasible or undesirable.