A Simple Method to Estimate Large Fixed Effects Models Applied to Wage Determinants and Matching

Nikolas Mittag

CERGE-EI Working Papers from The Center for Economic Research and Graduate Education - Economics Institute, Prague

Abstract: Models with high dimensional sets of fixed effects are frequently used to examine, among others, linked employer-employee data, student outcomes and migration. Estimating these models is computationally difficult, so simplifying assumptions that cause bias are often invoked to make computation feasible and specification tests are rarely conducted. I present a simple method to estimate large two-way fixed effects (TWFE) and worker-firm match effect models without additional assumptions. It computes the exact OLS solution including estimates of the fixed effects and makes testing feasible even with multi-way clustered errors. An application using German linked employer-employee data illustrates the advantages: The data reject the assumptions of simpler estimators and omitting match effects biases estimates including the returns to experience and the gender wage gap. Specification test detect both problems. Firm fixed effects, not match effects, are the main channel through which job transitions drive wage dynamics, which underlines the importance of firm heterogeneity for labor market dynamics.

Keywords: multi-way fixed effects; linked employer-employee data; matching, wage dynamics (search for similar items in EconPapers)
JEL-codes: C23 C63 J31 J63 (search for similar items in EconPapers)
Date: 2015-03
New Economics Papers: this item is included in nep-ecm, nep-lab and nep-lma
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Citations: View citations in EconPapers (9)

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