Question

Why is it said that estimation of a fixed effect model is inefficient?

Why is it said that estimation of a fixed effect model is inefficient?

Homework Answers

Answer #1

Estimation of fixed effect model is inefficient and the inefficiency can be heterogeneous, heteroskedastic and can follow a dynamic process. Estimation of fixed effect model involves solving the incidental parameters problem that affects maximum likelihood dummy variables estimator. This leads to inconsistent variance estimates (without affecting the frontier coefficients) and this makes the estimation of fixed effect model to be inefficient. True fixed effect models have non-stationary inefficiency.

The inefficiency can me marginalized by making use of simulation and use of maximum simulated likelihood principle.

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