Question

An economist wants to study the effect of income on savings. He collected data on 120 identical twins. Which of the following methods of estimation is the most suitable method, if income is correlated with the unobserved family effect, i.e.a) random effects estimationb) nonlinear least squared estimationc) least Squares Dummy Variable (LSDV) approachd) ordinary least squares estimation

Answer 1

The correct option is c) least Squares Dummy Variable (LSDV).

Step-by-step explanation:

Dummy variables can be used in dynamic panel data models to explain the effect of each individual unit of a cross section that is unobserved but accurately characterizes the model of relation. The individual effect is assumed to be fixed across time in each individual in the least squares dummy variable (LSDV) estimation. If the unobserved effect and the explanatory variables are correlated, the assumption of fixed effects gives more exact estimators than the assumption of random effects.

Therefore, the most suitable method, if income is correlated with the unobserved family effect is least Squares Dummy Variable (LSDV).

This implies that the correct option is c) least Squares Dummy Variable (LSDV).