Exact Inference in Fixed-Effect Regressions with Concentrated Identifying Variation

Stanis{\l}aw M. S. Halkiewicz

Papers from arXiv.org

Abstract: In fixed-effect regressions with many groups, fixed effects can absorb most identifying variation, leaving a handful of observations to carry what remains. When variation is this concentrated, conventional $t$-tests can reject a true null more than half the time, and any fixed critical value is either invalid or so conservative it has essentially no power. This paper builds an exact test from the design alone. A \textit{nuisance-annihilating contrast} is a linear combination of the treatment and fixed-effect dummies that eliminates the fixed effects without touching the outcome; sign-flipping these contrasts is then an exact symmetry of the null distribution at every sample size, under arbitrary heteroskedasticity. In two-way designs --- worker-firm, firm-time --- these contrasts are exactly the cycles of the bipartite mobility graph, so the movement that identifies the treatment effect is what makes exact inference possible. Exactness costs power: relative to an oracle test, a chosen set of cycles has an observable \textit{capture ratio} $\kap\in[0,1]$ and standard-error premium $\kap^{-1/2}$, and a packing algorithm resolves the capture-granularity trade-off. In the Grunfeld investment regression (single-observation score concentration $73.9\%$), 32 cycle contrasts capture $\kap=0.627$ of the identifying variation, giving an exact $95\%$ confidence interval of $[0.150,\,0.450]$.

Date: 2026-08, Revised 2026-08
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