Journal
ENERGY ECONOMICS
Volume 114, Issue -, Pages -Publisher
ELSEVIER
DOI: 10.1016/j.eneco.2022.106289
Keywords
Perfect multicollinearity; Two-way fixed effects; Oil price uncertainty; Economic policy uncertainty; Trade policy uncertainty
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This note addresses the problem of combining macro time series data with micro financial and accounting panel data, and points out the issue of perfect multicollinearity. It questions the findings of existing studies and offers practical ways to mitigate this problem.
This short note addresses a serious problem in combining macro (country-level) time series data, e.g., oil price uncertainty (OPU) or economic/trade policy uncertainty (EPU/TPU), with micro (firm-level) financial and accounting panel data, e.g., corporate leverage, investment, and innovation, to name a few. In most of the applications, the main interest is to assess the impacts of country-level explanatory variable on the firm-level dependent variable, with year fixed effects (along with other firm fixed effects, etc.) being included. Since the macro time series are the same for all firms in each year, it is straightforward to show that the macro time series variable is perfectly correlated with the year fixed effects, and thus unidentifiable. We employ three real data sets to illustrate the perfect multicollinearity issue, and our demonstrations cast doubt on the findings of several existing studies suffering from this issue. Finally, we also offer some practical ways to get around with (at least mitigate) this problem.
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