How do you fix omitted variable bias? Please give a simple, and elaborate response. An example...

How do you fix omitted variable bias? Please give a simple, and elaborate response. An example in addition will help.

Thank you!

Expert Solution

Panel models can include unobserved effects in your model. If the unobserved effects are correlated with the explanatory variables then use fixed effects as random effects are biased in such circumstances. If they are uncorrelated with the explanatory variables use random effects. The Hausman Test can be used to choose between fixed and random effects.

By running a pooled OLS on panel data you fail to take into account individual and/or time effects. Even if the omitted variable bias is always present in all econometric models, a panel data model with individual and/or time effects has the useful particularity to reduce it. I recommend running a fixed effects model instead, as it is likely to be more efficient than pooled OLS and consistent compared to a random effects model.

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orchestra answered 1 year ago

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