fixed effects and random effects

Badi H. Baltagi
From The New Palgrave Dictionary of Economics, Second Edition, 2008
Edited by Steven N. Durlauf and Lawrence E. Blume
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Abstract

Unobservable individual effects in panel data models are employed to control for heterogeneity. These can be thought of as random variables that are uncorrelated with the regressors, thus generating a random effects model. Alternatively, these random individual effects are allowed to be completely correlated with the regressors, thus generating a fixed effects model. The choice between these two alternatives is usually settled using a Hausman (1978) test. This article argues that one should interpret a rejection by the Hausman test as a rejection of the random effects model, not necessarily an endorsement of the fixed effects model.
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How to cite this article

Baltagi, Badi H. "fixed effects and random effects." The New Palgrave Dictionary of Economics. Second Edition. Eds. Steven N. Durlauf and Lawrence E. Blume. Palgrave Macmillan, 2008. The New Palgrave Dictionary of Economics Online. Palgrave Macmillan. 22 September 2017 <http://www.dictionaryofeconomics.com/article?id=pde2008_F000295> doi:10.1057/9780230226203.0584

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