Multiple Fixed Effects in Binary Response Panel Data Models

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This paper considers the adaptability of estimation methods for binary response panel data models to multiple fixed effects. It is motivated by the gravity equation used in international trade, where important papers such as Helpman, Melitz and Rubinstein (2008) use binary response models with fixed effects for both importing and exporting countries. Econometric theory has mostly focused on the estimation of single fixed effects models. This paper investigates whether existing methods can be modified to eliminate multiple fixed effects for two specific models in which the incidental parameter problem has already been solved in the presence of a single fixed effect. We find that it is possible to generalize the conditional maximum likelihood approach of Rasch (1960, 1961) to include two fixed effects for the logit. Surprisingly, despite many similarities with the logit, Manski’s (1987) maximum score estimator for binary response models cannot be adapted to the presence of two fixed effects. Monte Carlo simulations show that the conditional logit estimator presented in this paper is less biased than other logit estimators without sacrificing on precision. This superiority is emphasized in small samples. An application to trade data using the logit estimator further highlights the importance of properly accounting for two fixed effects.

JEL Code(s): C, C2, C23, C25, F, F1, F14