Another look at the instrumental variable estimation of error-components models

This article develops a framework for efficient IV estimators of random effects models with information in levels which can accommodate predetermined variables. Our formulation clarifies the relationship between the existing estimators and the role of transformation in panel data models. We characterise the valid transformations for relevant models and show the optimal estimators are invariant to the transformation used to remove individual effects. We present an alternative transformation for models with predetermined instruments which preserves the orthogonality among the errors. Finally, we consider models with predetermined variables that have constant correlation with effects and illustrate their importance with simulations.