Interactions in Fixed Effects Regression Models

Marco Giesselmann and Alexander Schmidt-Catran

No m78qf, SocArXiv from Center for Open Science

Abstract: An interaction in a fixed effects (FE) regression is usually specified by demeaning the product term. How-ever, algebraic transformations reveal that this strategy does not yield a within-unit estimator. Instead, the standard FE interaction estimator reflects unit-level differences of the interacted variables. This property allows interactions of a time-constant variable and a time-varying variable in FE, but may yield unwanted results if both variables vary within units. In such cases, Monte Carlo experiments confirm that the standard FE estimator of z∙x is biased if x is correlated with an unobserved unit-specific moderator of z (or vice-versa). A within estimator of an interaction can be obtained by first demeaning each variable and then demeaning their product. This “double-demeaned” estimator is not subject to bias caused by unobserved effect heterogeneity. It is, however, less efficient than standard FE and only works with T > 2.

Date: 2020-04-27
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Citations: View citations in EconPapers (16)

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Working Paper: Interactions in Fixed Effects Regression Models (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:osf:socarx:m78qf

DOI: 10.31219/osf.io/m78qf

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