st: Clustering of Standard Errors in a fixed effect model.

[natasha agarwal <agarwana2@googlemail.com>]

Dear Everyone,

I am trying to estimate an augmented production function where am
attempting to measure the effect of aggregate variable (FDI in a
region) on micro units (productivity of domestic firms). I use an
unbalanced panel data which spans for 5 years.

According to Moultan (1986) paper titled "An illustration of a pitfall
in estimating the effects of aggregate variables on micro units", it
mentions that is is essential to cluster at the aggregate level when
an aggregate regressor is specified in the right-hand side.

However, Woolridge 2002 in his book Cross-Section and Panel Data
mentions that clustering at the aggregate level when the number of
groups is less than the group size might not be correct.

I was wondering, if anyone could explain me what happens if one tries
to cluster at the aggregate level in a fixed effect model when the
group size (cluster size) is greater than number of groups (number of
clusters)?

Thanks
Natasha
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