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)provide identical results if there are only two years of data.
D)do not completely remove the time-invariant component of the error term.

Question

Quizplus · Accepted Answer

Fixed-effects models assume that the time-invariant component of the error term is not correlated with the independent variables, whereas first-differenced models do not make this assumption. Therefore, the best choice is A. Fixed-effects models and first-differenced models both add dummy variables to control for individual observations, but their underlying assumptions and methodology differ. Additionally, while first-differenced models eliminate the time-invariant component of the error term, fixed-effects models only partially remove it. Lastly, fixed-effects models and first-differenced models provide similar results if there are only two years of data, but they may differ if there are more observations available.

Fixed-Effects Models and First-Differenced Models