Weak and strong cross-section dependence and estimation of large panels
Article first published online: 18 FEB 2011
© 2011 The Author(s). The Econometrics Journal © 2011 Royal Economic Society
The Econometrics Journal
Volume 14, Issue 1, pages C45–C90, February 2011
How to Cite
Chudik, A., Pesaran, M. H. and Tosetti, E. (2011), Weak and strong cross-section dependence and estimation of large panels. The Econometrics Journal, 14: C45–C90. doi: 10.1111/j.1368-423X.2010.00330.x
- Issue published online: 18 FEB 2011
- Article first published online: 18 FEB 2011
- First version received: June 2009; final version accepted: June 2010.
- Common correlated effects (CCE) estimator;
- Strong and weak cross-section dependence;
- Weak and strong factors
Summary This paper introduces the concepts of time-specific weak and strong cross-section dependence, and investigates how these notions are related to the concepts of weak, strong and semi-strong common factors, frequently used for modelling residual cross-section correlations in panel data models. It then focuses on the problems of estimating slope coefficients in large panels, where cross-section units are subject to possibly a large number of unobserved common factors. It is established that the common correlated effects (CCE) estimator introduced by Pesaran remains asymptotically normal under certain conditions on factor loadings of an infinite factor error structure, including cases where methods relying on principal components fail. The paper concludes with a set of Monte Carlo experiments where the small sample properties of estimators based on principal components and CCE estimators are investigated and compared under various assumptions on the nature of the unobserved common effects.