Abstract
Unobservable individual effects in panel data models are employed to control for heterogeneity. These can be thought of as random variables that are uncorrelated with the regressors, thus generating a random effects model. Alternatively, these random individual effects are allowed to be completely correlated with the regressors, thus generating a fixed effects model. The choice between these two alternatives is usually settled using a Hausman (Econometrica 46:1251–1271, 1978) test. This article argues that one should interpret a rejection by the Hausman test as a rejection of the random effects model, not necessarily an endorsement of the fixed effects model.
This chapter was originally published in The New Palgrave Dictionary of Economics, 2nd edition, 2008. Edited by Steven N. Durlauf and Lawrence E. Blume
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Baltagi, B.H. (2008). Fixed Effects and Random Effects. In: The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-349-95121-5_2713-1
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DOI: https://doi.org/10.1057/978-1-349-95121-5_2713-1
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Publisher Name: Palgrave Macmillan, London
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