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A Simple Method to Estimate Large Fixed Effects Models Applied to Wage Determinants and Matching

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  • Mittag, Nikolas

    (CERGE-EI)

Abstract
Models with high dimensional sets of fixed effects are frequently used to examine, among others, linked employer-employee data, student outcomes and migration. Estimating these models is computationally difficult, so simplifying assumptions that are likely to cause bias are often invoked to make computation feasible and specification tests are rarely conducted. I present a simple method to estimate large two-way fixed effects (TWFE) and worker-firm match effect models without additional assumptions. It computes the exact OLS solution including estimates of the fixed effects and makes testing feasible even with multi-way clustered errors. An application using German linked employer-employee data illustrates the advantages: The data reject the assumptions of simpler estimators and omitting match effects biases estimates including the returns to experience and the gender wage gap. Specification tests detect both problems. The results suggest that firm fixed effects, not match effects, are the main channel through which job transitions drive wage dynamics, which underlines the importance of firm heterogeneity for labor market dynamics.

Suggested Citation

  • Mittag, Nikolas, 2016. "A Simple Method to Estimate Large Fixed Effects Models Applied to Wage Determinants and Matching," IZA Discussion Papers 10447, Institute of Labor Economics (IZA).
    • Handle: RePEc:iza:izadps:dp10447
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    References listed on IDEAS

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    2. Susan Dynarski & Brian Jacob & Daniel Kreisman, 2018. "How important are fixed effects and time trends in estimating returns to schooling? Evidence from a replication of Jacobson, Lalonde, and Sullivan, 2005," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 33(7), pages 1098-1108, November.
    3. Felder, Rahel & Frings, Hanna & Mittag, Nikolas, 2024. "How Does Potential Unemployment Insurance Benefit Duration Affect Reemployment Timing and Wages?," IZA Discussion Papers 17348, Institute of Labor Economics (IZA).

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    More about this item

    Keywords

    matching; linked employer-employee data; multi-way fixed effects; wage dynamics;
    All these keywords.

    JEL classification:

    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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