Econometric Analysis of Panel Data Models with Multifactor Error Structures

Hande Karabiyik, Franz C. Palm, Jean Pierre Urbain

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Economic panel data often exhibit cross-sectional dependence, even after conditioning on appropriate explanatory variables. Two approaches to modeling cross-sectional dependence in economic panel data are often used: the spatial dependence approach, which explains cross-sectional dependence in terms of distance among units, and the residual multifactor approach, which explains cross-sectional dependence by common factors that affect individuals to a different extent. This article reviews the theory on estimation and statistical inference for stationary and nonstationary panel data with cross-sectional dependence, particularly for models with a multifactor error structure. Tests and diagnostics for testing for unit roots, slope homogeneity, cointegration, and the number of factors are provided. We discuss issues such as estimating common factors, dealing with parameter plethora in practice, testing for structural stability and nonlinearity, and dealing with model and parameter uncertainty. Finally, we address issues related to the use of these economic panel models.

Original languageEnglish
Pages (from-to)495-522
Number of pages28
JournalAnnual Review of Economics
Early online date2 Aug 2019
Publication statusPublished - Aug 2019


  • common correlated effects
  • cross-sectional dependence
  • factor-augmented panel regression
  • nonstationary panels
  • panel data
  • principal components
  • stationary panels


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