# Another reason for choosing the FE model12 is that it can solve the endogeneity problem through

800 WordsApr 23, 20194 Pages
Another reason for choosing the FE model12 is that it can solve the endogeneity problem through using the FE-IV model; the variable GDP per capita-used as a proxy of income-could be an endogenous variable. An endogenous variables are variables that correlated with the error term (ε௜௧ ), while the variables that uncorrelated with the error term are called exogenous variables. The description of these terms explains that an endogenous variable is determined within the model itself while an exogenous variable is determined outside the model. To understand the endogeneity, we will use the classic regression equations that show the relationship between prices and wages: Price = ߚ0 + ߚ1Wage + ε௜௧ ………………………… (11) Wage = ߚ0௔ + ߚ1௕Price +…show more content…
As we reject the H°, the random effect model will produce biased estimates, so the FE model is used alternatively. In FE, the τ௜ is correlated with the regressor ܺ௜௧ . 13 RGDP per capita is endogenous variable in our model because of reverse causality; the effect between corruption and RGDP goes in both directions; either RGDP affects corruption or corruption affects RGDP. 19 Chapter 3 Empirical Evidence estimator is biased even in large sample and the FE-IV t-statistic and confidence intervals are not true. In this paper, we will use one instrument which is the RGDP of the great importer in 2000. Here is a description why I choose this instrument. First, a country that buys most of other country‟s export can definitely increase the GDP of that country, as the exports will be included in the country‟s GDP calculations. Second, there is no any reason for the GDP of one country to affect the corruption level of another country, which means; there is no any correlation between the GDP of great importer and the domestic factors in the country at which it buys most of its exports. 3.3.3 Regression Results and Discussion Although some of the results in this paper support that in previous papers, but it shows new other findings. Using FE- IV estimation technique through using the RGDP of great importer as an instrument for RGDP per capita, we find that, income, political stability and