V#26 Fixed Effect Model : Introduction to Panel Data Part 2
Channel: Zahid Asghar
Date: 2020-11-12

Advantages and limitations of fixed effects regression

Advantages
• You can control for unobserved variables that:
• vary across states but not over time, and/or 
• vary over time but not across states
• More observations give you more information
• Estimation involves relatively straightforward extensions of multiple regression

• Fixed effects regression can be done three ways:
1. “Changes” method when T = 2
2. “n-1 binary regressors” method when n is small
3. “Entity-demeaned” regression
• Similar methods apply to regression with time fixed effects and to both time and state fixed effects
• Statistical inference: like multiple regression.

Limitations/challenges
• Need variation in X over time within states
• Time lag effects can be important
• You should use heteroskedasticity- and autocorrelation-consistent (clustered) standard errors if you think uit could be correlated over time