Fixed-effects models and first-differenced models
A)assume that the time-invariant component of the error term is not correlated with the independent variables.
B)both add dummy variables to control for individual observations.
C)control for unobserved heterogeneity.
D)do not completely remove the time-invariant component of the error term.

Question

Quizplus · Accepted Answer

Both fixed-effects models and first-differenced models control for unobserved heterogeneity, which is often a concern in panel data analysis. However, fixed-effects models do not completely remove the time-invariant component of the error term, which may still bias the estimate of the coefficients. First-differenced models, on the other hand, remove the time-invariant component but may suffer from a loss of information due to the differencing process. Both models add dummy variables to control for individual observations, but the key difference lies in their treatment of the time-invariant component of the error term. Therefore, the best choice in this case is C.

Fixed-Effects Models and First-Differenced Models