Testing FE Vs. RE
We can test whether a fixed or random effects model is appropriate using a Hausman test.
- :
- :
If is true, both and are consistent, but only is efficient. If is true, is consistent and is not.
where
The Hausman test is a specification test so a large test statistic might be indication that there might be Errors in Variables (EIV) or our model is misspecified. If the FE assumption is true, we should find that .
A simple heuristic is that if there could be EIV.
Read more about this topic: Fixed Effects Model
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