Factor models in panels with cross-sectional dependence: an application to the extended SIPRI military expenditure data

Article, Book English OPEN
Smith, Ron P. ; Cavatorta, Elisa (2016)
  • Publisher: Birkbeck College, University of London
  • Related identifiers: doi: 10.1080/10242694.2016.1261428
  • Subject: /dk/atira/pure/subjectarea/asjc/2000/2002 | Military expenditures | panel data | Social Sciences (miscellaneous) | ems | factor models | Economics and Econometrics | /dk/atira/pure/subjectarea/asjc/3300/3301

Strategic interactions between countries, such as arms races, alliances and wider economic and political shocks, can induce strong cross-sectional dependence in models of military expenditures using panel data. If the assumption of cross-sectional independence fails, standard panel estimators such as fixed or random effects can lead to misleading inference. This paper shows how to improve estimation of dynamic, heterogenous, panel models of the demand for military expenditure allowing for cross-sectional dependence in errors using two approaches: Principal Components and Common Correlated Effect estimators. Our results show that it is crucial to allow for cross-section dependence and there are large gains in it by allowing for both dynamics and between country heterogeneity in demand models of military expenditures. Our estimates show that mean group estimation of error correction models using the Common Correlated Effect approach provides an effective modelling framework.
  • References (20)
    20 references, page 1 of 2

    Bai, Jushan (2009), `Panel data models with interactive xed e ects', Econometrica 77(4), 1229{1279.

    Brauner, Jennifer (2015), `Military spending and democracy', Defence and Peace Economics 26(4), 409{423.

    Breitung, Jorg and M Hashem Pesaran (2008), `Unit roots and cointegration in panels', The Econometrics of Panel Data pp. 279{322.

    Cavatorta, Elisa (2010), `Unobserved common factors in military expenditure interactions across mena countries', Defence and Peace Economics 21(4), 301{316.

    Chudik, Alexander and M Hashem Pesaran (2011), `In nite-dimensional vars and factor models', Journal of Econometrics 163(1), 4{22.

    Chudik, Alexander and M Hashem Pesaran (2013), `Econometric analysis of high dimensional vars featuring a dominant unit', Econometric Reviews 32(5-6), 592{ 649.

    Chudik, Alexander and M Hashem Pesaran (2015a), `Common correlated e ects estimation of heterogeneous dynamic panel data models with weakly exogenous regressors', Journal of Econometrics 188(2), 393{420.

    Chudik, Alexander and M Hashem Pesaran (2015b), Large panel data models with cross-sectional dependence: a survey, in B.Baltagi, ed., `The Oxford Handbook on Panel Data', Oxford University Press, chapter 1.

    Coakley, Jerry, Ana-Maria Fuertes and Ron Smith (2006), `Unobserved heterogeneity in panel time series models', Computational Statistics & Data Analysis 50(9), 2361{2380.

    Collier, Paul and Anke Hoe er (2007), `Unintended consequences: Does aid promote arms races?', Oxford Bulletin of Economics and Statistics 69(1), 1{27.

  • Metrics
    No metrics available
Share - Bookmark