When Does $N$ Buy Precision? Heterogeneous Responses to Aggregate Shocks in Micro Panels

Mahmut Ablay, Mengshan Xu and Endong Wang

Papers from arXiv.org

Abstract: Panel local projections (panel LPs), valued for their flexibility and robustness, are widely used to estimate heterogeneous responses to aggregate shocks from micro data. This paper, however, highlights the potential of panel vector autoregressions (panel VARs) and characterizes the trade-off between the efficiency of panel VARs and the robustness of panel LPs. In contrast to existing results in the time-series literature, we show that under correct specification, panel VAR estimators of the heterogeneous responses converge at rate $(NT)^{-1/2}$, whereas panel LP estimators converge at rate $T^{-1/2}$. When the heterogeneous response function is nonparametric, the panel VAR incurs a nonparametric rate loss, whereas the panel LP retains its parametric $T^{-1/2}$ rate under suitable smoothness and panel-growth conditions. We provide a Hausman-type test for choosing between them, with power against two forms of panel VAR misspecification. We apply panel LPs and panel VARs to Turkish administrative firm-level data to estimate heterogeneous firm responses to monetary policy shocks.

Date: 2026-10
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