Question

Explain in your own words what is a Fixed Effects in Panel Regression

Answer 1

Ans)- A fixed effects regression is an estimation technique employed in a panel data setting that allows one to control for time-invariant unobserved individual characteristics that can be correlated with the observed independent variables.

In other words, Fixed effect in panel regression explore the relationship between predictor and outcome variables within an entity (country, person, company, etc.). Each entity has its own individual characteristics that may or may not influence the predictor variables.

When using Fixed-effect we assume that something within the individual may impact or bias the predictor or outcome variables and we need to control for this. This is the rationale behind the assumption of the correlation between entity’s error term and predictor variables. FE remove the effect of those time-invariant characteristics so we can assess the net effect of the predictors on the outcome variable.

We have Fixed-Effect regression model-

Note: In this model, captures the unobserved time-invariant heterogeneities across the entities.