Abstract
In panel data models with rational expectations the conventional fixed-effects or random-effects treatment of the error components leads to inconsistency because instruments are only predetermined, and not strictly exogenous. In panel data models with predetermined instruments, the standard fixed-effects and random-effects procedures become inconsistent because of similar reasons. The presence of time-invariant individual effects creates certain structure of autocorrelation in the errors, and the conventional panel-data procedures are alternative ways of correcting for this. Efficient estimation and testing strategies in the context of panel data models with rational expectations are quite different from the conventional procedures. The chapter discusses the efficient estimation of such models in a generalized method of moments (GMM) framework, certain specification tests, and certain specification tests where the Euler equation for optimal consumption is estimated and analyzed using the Michigan Panel of Income Dynamics data.
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