Monte Carlo Investigation of the Initial Values Problem in Censored Dynamic Random-Effects Panel Data Model

Abstract

Three designs of Monte Carlo experiments are used to investigate the initial-value problem in censored dynamic random-effects (Tobit type 1) models. We compared three widely used solution methods: naive method based on exogenous initial values assumption; Heckman's approximation; and the simple method of Wooldridge. The results suggest that the initial values problem is a serious issue: using a method which misspecifies the conditional distribution of initial values can cause misleading results on the magnitude of true (structural) and spurious state-dependence. The naive exogenous method is substantially biased for panels of short duration. Heckman's approximation works well. The simple method of Wooldridge works better than naive exogenous method in short panels, but it is not as good as Heckman's approximation. It is also observed that these methods performs equally well for panels of long duration.