Incidental Parameters Bias in Panel Local Projections Non-Monotone Horizon Pattern and Correction

Gerdie Everaert ()
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Gerdie Everaert: -

Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium from Ghent University, Faculty of Economics and Business Administration

Abstract: Local projections (LPs) are a widely used method for estimating impulse responses. While LP estimators are consistent as the number of time periods T tends to infinity under standard conditions, they exhibit non-negligible bias in finite samples. This bias is particularly relevant in panel data settings, where the number of individuals N may be large but T relatively small. In this paper, we derive an analytical expression for the incidental-parameters bias in the LP estimator with individual fixed effects. We show that this bias exhibits a non-monotone pattern across the projection horizon: it increases at intermediate horizons, where it can substantially exceed the standard dynamic panel bias even for moderate T, before declining at longer horizons. We propose an iterative bias-correction procedure that, when suitably initialized, effectively eliminates the incidental-parameters bias across the entire projection horizon.

Keywords: Local projections; panel data; fixed effects; incidental parameters bias; bias correction (search for similar items in EconPapers)
JEL-codes: C13 C32 C33 (search for similar items in EconPapers)
Pages: 75 pages
Date: 2026-06
New Economics Papers: this item is included in nep-ets and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:rug:rugwps:26/1145

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