Common Factors and Spatial Dependence : An Application to US House Prices

This paper considers panel data models with cross-sectional dependence arising from both spatial autocorrelation and unobserved common factors. It proposes estimation methods that employ cross-sectional averages as factor proxies, including the 2SLS, Best 2SLS, and GMM estimations. The proposed estimators are robust to unknown heteroskedasticity and serial correlation in the disturbances, unrequired to estimate the number of unknown factors, and computationally tractable. The paper establishes the asymptotic distributions of these estimators and compares their consistency and efficiency properties. Extensive Monte Carlo experiments lend support to the theoretical findings and demonstrate the satisfactory finite sample performance of the proposed estimators. The empirical section of the paper finds strong evidence of spatial dependence of real house price changes across 377 Metropolitan Statistical Areas in the US from 1975Q1 to 2014Q4