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Measurement errors in a spatial context

Article in Regional Science and Urban Economics · January 2012

DOI: 10.1016/j.regsciurbeco.2011.08.004

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Regional Science and Urban Economics 42 (2012) 114–125

Contents lists available at SciVerse ScienceDirect

Regional Science and Urban Economics

j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / r e g e c

Measurement errors in a spatial context ☆

Julie Le Gallo a,⁎, Bernard Fingleton b, 1
a
CRESE, Université de Franche-Comté, 45D, avenue de l'Observatoire, 25030 Besançon Cedex, France
b
Department of Economics, University of Strathclyde, Sir William Duncan Building, 130 Rottenrow, Glasgow G4 0GE, UK

a r t i c l e i n f o a b s t r a c t

Article history: Measurement error in an independent variable is one reason why OLS estimates may not be consistent.
Received 12 October 2010 However, as shown by Dagenais (1994), in some circumstances the OLS bias may be ameliorated somewhat
Received in revised form 1 August 2011 given the presence of serially correlated disturbances, and OLS may prove superior to standard techniques
Accepted 8 August 2011
used to correct for serial correlation. This paper considers the case of cross-sectional regression models with
Available online xxxx
measurement errors in the explanatory variables and with spatial dependence. The study focuses on the
JEL classification:
evidence provided by an empirical illustration and Monte Carlo experiments examining measurement error
C13 impact in the presence of autoregressive error processes and autoregressive spatial lags.
C21 © 2011 Elsevier B.V. All rights reserved.
R15

Keywords:
Measurement error
Spatial autocorrelation
Instrumental variables
GMM
Monte-Carlo simulations

1. Introduction endogeneity may come from simultaneity or omitted variable(s)

In cross-sectional models with spatial data, spatial dependence
often arises as a consequence of spatial interaction between
individuals and geographic spillovers. When it involves simultaneous
interaction between values of a dependent variable y at different
locations, it can be modeled in a regression model with a spatial lag
variable of the form Wy as an explanatory variable, where W is a
spatial weights matrix and y is the vector of observations on the
dependent variable. As is well-known in the spatial econometrics
literature, the spatial lag is endogenous and the appropriate treatment
and estimation of the endogenous spatial lag has therefore received a
good deal of attention (Cliff and Ord, 1981; Upton and Fingleton,
1985; Anselin, 1988, 2006). However, latterly the analysis of other
possible endogenous explanatory variables has also begun to garner
attention from an applied (Anselin and Lozano-Gracia, 2008; Dall'erba
and Le Gallo, 2008) and a theoretical (Kelejian and Prucha, 2007;
Fingleton and Le Gallo, 2008a, 2008b, 2009) perspective. While
☆ This paper has been presented at the 9th International Workshop Spatial
Econometrics and Statistics (Orléans, France, 24–25 June 2010). We thank F. Bavaud, J.
Mutl and two anonymous referees for their useful comments. The usual disclaimer
applies.
⁎ Corresponding author. Tel.: + 33 3 81 66 67 52; fax: +33 3 81 66 65 76.
E-mail addresses: jlegallo@univ-fcomte.fr (J. Le Gallo), bf100@cam.ac.uk
(B. Fingleton).
1
Tel.: + 44 141 548 3842; fax: +44 141 548 4445.
correlated with variables in the regression model, our aim here is to
focus on the specific case of endogeneity due to measurement errors
(errors-in-variables or EIV).
Often, we can regress variables measured with error with little or
no consequence. For instance, measurement error in a dependent
variable is absorbed as part of the error term and therefore this form
of measurement error has no effect on the consistency of parameter
estimates. Also, while an observed explanatory variable may be an
imprecise measure of an unobserved variable, we may be happy to
estimate the model using the observed explanatory variable and treat
that as the true object of interest, without wishing to infer anything
about the unobserved variable. The presence of measurement error
becomes an issue when we are actually interested in obtaining
consistent estimates of a parameter relating to the unobserved
variable, but only observe a variable that is the unobserved variable
plus measurement error. In this case, the OLS estimate of the
parameter obtained using the observed variable is a biased and
inconsistent estimate of the parameter on the unobserved variable.
Temple (1998) has demonstrated that estimated technology
parameters and convergence rates obtained from cross-sectional
Solow growth models are highly sensitive to measurement error.
However, it is interesting to note that Dagenais (1994) shows that, in
some circumstances, OLS bias may be ameliorated somewhat given the
presence of serially correlated disturbances, and OLS may prove superior
to standard techniques used to correct for serial correlation. This paper

0166-0462/$ – see front matter © 2011 Elsevier B.V. All rights reserved.
doi:10.1016/j.regsciurbeco.2011.08.004
 Author's personal copy

J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125 115

looks at the parallel case of cross-sectional regression models with The author assumes serial correlation in the disturbances of the
measurement errors in the explanatory variables and with spatial form:
dependence, exploring whether the conclusions of Dagenais carry over
to the spatial setting using the evidence of Monte Carlo experiments. ut = ρu ut−1 + εt

 ð4Þ
The outline of the paper is as follows. First, we recall some important
εt e Nid 0; σ 2
results pertaining to measurement errors. Second, the contribution of
Dagenais (1994) is analyzed. Third, we present our research problem in
a spatial context and provide some empirical evidence. Fourth, the OLS requires disturbances that are IID, and to achieve this one can
simulation set-up is defined and the results analyzed. Finally, we transform the variables using quasi-differences, so that as Yt* = Yt −

present our Monte-Carlo simulation results. The final section provides ρuYt − 1 and X̃ t = X̃ t −ρu X̃ t−1 ; jρu j < 1 and hence εt = ut − ρuut − 1 ~
2
some concluding remarks and future research directions. Nid(0, σ ). In other words, using this GLS approach, we can simply
 
estimate the model Yt = b1 X̃ t + εt using standard OLS.

2. Theoretical and empirical background However, we know that since X̃ t contains measurement error, OLS

will incur bias, equal to −b1 ·σξ = σ 2 , where σ 2 is the variance of X̃ t
2
2 X̃ X̃
To see the way in which measurement error affects the bias and and E(ξ′ξ) = σ ξ where X̃ t = Xt + ξt . Following earlier work by
consistency of OLS parameter estimates in a simple regression model Grether and Maddala (1973), Dagenais (1994) shows that when
Yi = b1Xi + ui with ui ~ IID(0, σ 2), assume that the explanatory variable one controls for serial correlation in the disturbances, where the
Xi is unobserved, but is represented by the observed variable explanatory variable also incurs measurement errors, the method of
X̃ i = Xi + ξi , where ξi ~ IID(0, σ ξ2) is independent of Y, X and u. We estimation typically adopted to eliminate error dependence may
wish to estimate the true relationship
Yi =b1Xi + ui. Suppose we increase bias. Therefore, in the regression Yt = b1 X̃ t + ut , the bias
estimate Yi = b1 X̃ i + ηi , since ηi = b1 Xi − X̃ i + ui = ui −b1 ξi then under OLS will be equal to −b1 ·σξ2 = σ 2 , and given that σ 2 N σ 2 , we
X̃ X̃ X̃
Covð X̃ i ; ηi Þ≠0 and the OLS estimator b̂1 is biased and inconsistent. expect to see greater bias under GLS, equal to −b1 ⋅ σξ2 = σ 2 , than
2 2 X̃
The amount of bias induced by EIV depends on the variance of the under OLS. Since, with cov(σ X, σ ξ ) = 0:
measurement error in relation to the variance of the regressor. It is

2 2 2
possible to show that, since ξ and h u0 are
i assumed to be independent, var X̃ = σ X̃ = σX + σξ ; ð5Þ
and given that E(ξ′ξ) = σ ξ2 and E X̃ X̃ = σ 2 , the bias is:
X̃


 2 2
var X̃ = ð1−ρÞ var X̃ t = σ X̃  ð6Þ
h i σ ξ2
0 −1 
E ð X̃ X̃Þ −b1 ξ′ ξ = −b1 2 : ð1Þ
σ 2 2
and given ρb 1 it follows that σ X̃ > σ X̃  :Also, typically with serial
X̃
correlation in Xt, the variance of Xt is greater than the variance

 of X*.
t The
2
Also, since σ 2 = σX2 + σξ2 , then the bias is equal to: variance of the
.
variable Xt = ρXt−1 + ε, where ε e IID 0; σ ε and |ρ|b 1,
X̃
is σX2 = σ ε2 1−ρ2 . In contrast, the variance of X*=X t
2
t −ρXt − 1 is σε .

 1 This suggests that the GLS bias incurred with quasi-differencing the
bias b̂1 = −b1 ð2Þ observable variable will be greater than the bias when one does not
1+π
attempt to allow for serial dependence in the disturbances.
where π = σ X2/σ ξ2 is the signal to noise ratio. If σ ξ2 N σ X2 then the bias Dagenais (1994) carries out Monte Carlo experiments in which
increases greatly. This result means that OLS underestimates the true Yt = b1Xt + ut, X̃ t = Xt + υt ; ut = ρu ut−1 + εt ; Xt = ρx Xt−1 + ξt , and
regression coefficient in the presence of measurement error, in other the errors are also serially correlated, so that υt = ρυυt − 1 + ωt. In
words it is always biased towards zero, even asymptotically. In fact, these, the disturbance terms are assumed to be normally distributed,
this provides a lower bound for the true coefficient. are each independent of the corresponding right hand side variables,
These results carry over to EIV for multiple regression models. If additionally υ is independent of u, ε is independent of X and υ, and ξ
just one of several variables is subject to EIV, it turns out that not only and ω are also independent of all other stochastic variables. The
is the coefficient on the badly measured variable biased towards zero, various autoregressive coefficients (the ρs) all satisfy the stationarity
but the coefficients on other correlated regressors are affected also, condition of being less than 1 in absolute value.
although in unknown directions and consequently ‘a badly measured
variable contaminates all the least squares estimates’ (Greene, 2003). 4. Measurement error with spatial data
This effect is known as the contamination bias. Moreover, with more
than one variable with measurement error, the problems are 4.1. The research problem
exacerbated, but ‘there is very little that can be said’.
The problem of measurement error in a spatial context was Consider next the parallel case of spatially autocorrelated
highlighted by Temple (1998), who looked at the highly influential disturbances and error in variables. Is it possible that the results
estimates made by Mankiw et al. (1992) of the Solow–Swan growth found by Dagenais (1994) carry over to the spatial set-up? Assume
model. This paper has been widely cited and is the basis of much that the disturbance process for one observation i is given by:
subsequent work. It provided evidence in favor of diminishing returns to
accumulable factors and supported the notion of conditional conver- ui = ρu ∑ wij uj + εi with i = 1…n ð7Þ
j≠i
gence of economies at a rate of 2% per annum. However, he argues that
this famous result could be entirely due to measurement error.
where εi is identically and normally distributed. In matrix terms, let W
denote the n by n spatial weights matrix for n locations, with typical
3. The contribution of Dagenais (1994)
cell wij. Assume for simplicity that wij = 1 if locations i and j are
‘nearby’ and wij = 0 otherwise. Written in matrix terms, the
Dagenais (1994) analyzes the EIV problem in a time-series context.
disturbance process becomes:
More specifically, consider a model in which:

Yt = b1 X̃ t + ut with t = 1…T ð3Þ u = ρu Wu + ε ð8Þ

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116 J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125
Assume also that Y = X̃b + u, which X̃ is an n by k matrix of
observable variables, b is a k by 1 column vector of regression
coefficients, and Y and u are n by 1 column vectors. The variance-
covariance matrix for this model is V = σ 2D, D ≠ I, in which σ 2 is a
scalar and D is a symmetric matrix with a positive determinant. The
GLS transformation described above in the time series context is
 
Y  = X̃ b + ε  , so that now V = σ 2I. In this, Y  = P −1 Y; X̃ = P 1 X̃
−1 −1
′
and n = P u, and P = (I - ρW), with P P = D. Given ρ, and thus
having eliminated spatially dependent disturbances, the regression

Y  = X̃ b + ε  can be estimated via OLS. However, as we have seen,
this GLS approach may incur greater bias than under OLS estimation of
the regression Y = X̃b + u. Hence, analogous to Dagenais, we
examine with an empirical example the effect of measurement error
in X for two estimators. One is ML estimation in which we model error
dependence, as typically accomplished in the spatial econometrics
literature. The other is OLS in which we ignore error dependence.
Based on Dagenais (1994), ML should lead to greater bias in estimated
b than occurs when ignoring the existence of spatial autocorrelation.
4.2. Preliminary evidence using real data
There are various situations in which we might encounter
measurement error in practice. For example, many countries build
databases in which the accuracy of the variables is undoubtedly
measured with error, and also in many cases pragmatic decisions have
to be made to use a variable that is only a proxy of a true variable.
With census data, for instance, detailed data for small areas may not
be available immediately, and therefore an analyst might choose to
compromise by constructing variables for small areas from available
data for larger spatial units, rather than wait for the release of the
micro-level data. This motivates one of our examples below.
Undoubtedly such a construction would only be an approximation
to the true values of the variable. In this section, we illustrate the
impact of measurement error in the context of the convergence of the
EU regional economies. In order to estimate the rate of convergence,
we estimate a very simple model in which the log of GVA per worker
by NUTS2 region for 2003 is regressed on the log level of GVA per
worker for 1995 plus a few covariates. The data relate to 255 NUTS2
regions of the EU plus Switzerland and Norway.
This specification is based on the neoclassical convergence model,
obtained by linearizing the dynamics around the steady state using a
Taylor series expansion, and then integrating to obtain the well-
known neoclassical reduced form:
−βT
ð1 = T Þ ln yt = α−ð1 = T Þe ln yt−T + ut ð9Þ
in which t denotes the current year, and t − T an earlier year; β is the
annual rate of convergence towards steady state, u is the disturbance
term, and α is the steady state level of GVA per worker towards which
each region converges as βT becomes large. Of course this specification
can be elaborated, because there are numerous simplifying assumptions
embodied within this specification, for example we assume that the
capital share, the savings rate, the rate of technological progress, the
depreciation rate and the population growth rate are constant across
regions. In our model, although it remains simple, we add covariates to
try to pick up some of these effects, and also add an autoregressive error
process so that:
ut = ρWu

t+  εt
ð10Þ
εt e N 0; σ 2
In order to operationalize this model, W is a matrix of interregional
‘distances’, in our case with 1 s indicating that regions are contiguous
and 0 otherwise, standardized so that rows sum to 1.
The expectation is that a regression coefficient will be estimated
that is significantly below 1, which would indicate that the economies
are converging. In order to simulate the impact of measurement error,
we assume that the observed level of GVA per worker is measured
without error (the data are official statistics published mainly by the
EU commission). Of course this may not be true, but under this
assumption we estimate the ‘true’ convergence rate based on the
regression coefficient on the 1995 log level. We then introduce
measurement error into this regressor. We obtain the relative bias by
fitting our two alternative models; one (the SEM) is the same as the
specification used to obtain the ‘true’ regression coefficient, in other
words comprising the same covariates and spatial autoregressive
error process, but the regressor used is the log of the 1995 GVA per
worker 2 plus measurement error. The second model omits the spatial
error process but is otherwise identical to the SEM specification. This
is estimated by OLS. The first model is estimated by maximizing the
likelihood using an iterative routine, and the second is the outcome of
fitting the model by OLS. The anticipation is that, following Dagenais,
controlling for spatial error dependence will introduce more bias than
simply estimating the model by OLS.
Consider first our basic specification assuming no errors in variables
leading to the ‘true’ annual rate of convergence. The results are
summarized by Table 1, column 4. Table 1 shows that in addition to the
main regressor of interest, the log of GVA per worker (ln GVA pw), we
include ‘new entrants’, which is a dummy variable equal to 1 if the region
is part of a new entrant3 country into the EU and equal to zero otherwise.
The covariate ‘Ln emp. Density’ is the natural logarithm of density of
employment per square km, which is included to pick up the effects of
capital cities and large urban centers. The ‘true’ rate of convergence is
provided by the estimated coefficient for ln GVA pw in 1995 (indicated by
the column SEM, no error in variable, or EIV). Table 1 gives the point
estimate for b1, equal to 0.801066 together with the 95% confidence
interval (0.7303, 0.8718). Denote the annual convergence rate by β,
which is given by β=−ln(b1)/T with standard error is se(β)= se
(b1)/(Te− βT). We can calculate the half-life equal to the time by which the
expected log of GVA per worker equals one half of its original value plus α,
which is given by ln(2)/β. Hence for our model with no measurement
error, we find that the annual convergence rate is 0.0276 and the half-life
is about 25 years.
Consider next what happens when we introduce errors into our
measure of ln GVA pw in 1995. Under the more artificial of our two
scenarios, this is achieved by adding ‘rnd’, which is equal to a unit normal
random variable multiplied by π(equal to 0.15), giving the variable g=ln
GVA pw in 1995+ rnd. The chosen value of π produces estimates and bias
comparable to those obtained in our more realistic measurement error
example given below. Table 1 shows that, relative to the ‘true’ coefficient,
the estimated coefficient given by ML is more significantly negatively
biased than is the OLS estimate, meaning that the rate of convergence is
positively biased. Note that var(g)= 0.5030.

By comparison, calculating
the spatially filtered variable P −1 g = I ρ̂WÞg we obtain var(P− 1g)
=0.1491. This is, by analogy with Dagenais, consistent with the smaller
OLS bias. In order to carry out the spatial filtering, we use ρ̂ = 0.591997 as
estimated by the SEM (Table1). Observe that spatially filtering regressors
 
X̃ and regressand Y* in this way, we can fit Y  = X̃ b + ε  by OLS
(equivalently GLS) and obtain estimates b̂ ‘identical’ to those given by ML
estimation of the SEM specification. This is analogous to the use of quasi-
differencing in the non-spatial case above.
Table 2 gives the outcome of using the mean GVA pw, denoted by
‘Ln mean GVA pw 1995’, instead of the ‘true’ value. For the larger and
older EU members, 4 we allot NUTS1 region means to the NUTS2
2
The variable 'ln GVA pw 1995' is highly spatially autocorrelated. The value of
Moran's I using the (unstandardized) contiguity matrix is 0.8920, the expected value
under the null is −0.0039, the variance is 0.0016, z = 22.2905 which has a p-value of
almost 0 in the N(0,1) distribution. This is a very relevant observation, as we show
subsequently.
3
The new entrant countries are the Czech Republic, Estonia, Hungary, Lithuania,
Latvia, Poland, Slovenia and Slovakia.
4
Austria, Belgium, Germany, Spain, France, Greece, Italy, Netherlands, Sweden, UK.
 Author's personal copy

J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125 117

Table 1 Table 2
Estimates with and without measurement error. Parameter estimated based on NUTS 1 and NUTS 0 data.

π = 0.15 SEM (with EIV) OLS (with EIV) SEM (no EIV) SEM (with EIV) OLS (with EIV) SEM (no EIV)

Constant 6.235973 5.504855 2.279034 Constant 6.305478 5.366299 2.279034

(18.365625) (18.426776) (6.260786) (11.455802) (12.250507) (6.260786)
Ln GVA pw 1995 0.408450 0.488007 0.801066 Ln mean GVA pw 1995 0.387640 0.495164 0.801066
(+rnd = with eiv = g) (0.3427, 0.4742) (0.4303, 0.5457) (0.7303, 0.8718) (0.2837, 0.4916) (0.4188, 0.5715) (0.7303, 0.8718)
New entrants −0.506982 −0.458513 0.127931 New entrants − 0.485747 −0.460696 0.127931
(− 7.473842) (−8.108535) (1.979711) (−4.866630) ( −6.479082) (1.979711)
Ln Emp. density 0.115874 0.070736 0.046030 Ln Emp. density 0.182275 0.100811 0.046030
(4.471489) (2.980003) (2.396382) (6.460657) (3.807168) (2.396382)
ρ 0.591997 – 0.744998 ρ 0.655972 – 0.744998
(10.750996) (18.379250) (13.263662) (18.379250)
R² 0.9454 0.9175 0.9744 R² 0.9330 0.8949 0.9744
2 2
R 0.9447 0.9166 0.9741 R 0.9322 0.8937 0.9741
σ2 0.0159 0.0244 0.0075 σ2 0.0195 0.0311 0.0075

regions. For the smaller and newer EU ‘members’ 5 we use national
averages (NUTS 0). By using the means by NUTS1 or NUTS0 region
rather than the NUTS 2 data, we are inducing measurement error. The
effect is to again produce negative bias, with the OLS estimate of b1
less negatively biased than ML taking account of the error dependence
in the data. Again this case this is reflected by the larger variance of ‘Ln
mean GVA pw 1995’ (0.4613) compared with the variance of the
spatially filtered ‘Ln mean GVA pw 1995’, which is equal to 0.1067.
5. Monte-Carlo simulation
5.1. The experimental set-up
We begin with the following model:
yi = β1 + β2 xi1 + β3 xi2 + ui with i = 1…n
where xi is a non-stochastic explanatory variable, β is an unknown
parameter to be estimated and ui is a normally distributed random
disturbance. The xi1's are not observable. Instead, they are measured
with errors. We observe:
where ωi is normally distributed and is independent of all the
stochastic variables of the model. Indeed, Dagenais (1994) indicates
that it is realistic that both the error terms and explanatory variables
are correlated (temporally in his case, spatially in our case). Moreover
“although very little is known about the nature and the importance of
measurement errors in economic data, the measurement errors might
also be serially correlated, but presumably less so than the true data
series themselves”. Therefore we also assume that the measurement
errors are spatially correlated.
Consider now these different aspects again but in matrix form. The
model is written as:
y = βx + u ð17Þ
where β' = [β1 β2 β3]' and x is an n by 3 matrix with x = [en x1 x2] and
ð12Þ en is the unit vector of order n. The vector x1 is observed with error.
Instead, we observe:
x̃1 = x1 + v ð18Þ
with:

−1
x̃i1 = xi1 + vi ð13Þ u = ðI−ρu W Þ ε ð19Þ

−1
where vi is a normally and independently distributed stochastic x1 = ðI−ρx W Þ ðx3 + x4 + x5 + ξÞ ð20Þ
measurement error, which is independent of the xi's as well as of the
−1
ui's. On the contrary, yi is measured without error. The error terms ui v = ðI−ρv W Þ ζ ð21Þ
are spatially autocorrelated:
On the other hand, the estimated model is:
ui = ρu ∑ wij uj + εi ð14Þ
j≠i 
y = βx̃ + u ð22Þ
h i
where εi is normally distributed and is independent of vi. with x̃ = en x̃1 x2 .
The x1i's are also spatially correlated:
The Monte-Carlo simulation runs as follows:
xi1 = ρx ∑ wij xj1 + xi3 + xi4 + xi5 + ξi ð15Þ
j≠i • First, we generate x1 using Eq. (20) with a given value of ρx.
• Then, we generate the measurement errors in a similar manner
where x3, x4 and x5 are random normal variables with variance equal using Eq. (21) with a given value of ρv. We can consider different
to 0.25 and ξi is a normally distributed innovation with variance 0.25, values for the variance of v, corresponding to various percentages of
which is independent of all the stochastic variables of the model. We the variance of x.
make x1 depend on x3, x4 and x5 and we then use x4 and x5 as optimal • Then, the error terms u are generated using Eq. (19) with a given
instruments in the simulation. In order to be general x1 is also value of ρu and assuming that ε → Nid(0, 1).
assumed to be spatially autocorrelated as is usually the case in applied • Finally, the y are computed using Eq. (17) and x̃1 is computed using
work. Finally, the errors in the variables are spatially correlated: Eq. (18).

vi = ρv ∑ wij vj + ωi ð16Þ Considering specifically the second point, we need to generate v with
j≠i a variance that is a fraction λ of the variance of x1. However, as both v and
x1 are spatially autocorrelated, they are also heteroskedastic. Since we
5
Czech Republic, Denmark, Estonia, Finland, Hungary, Ireland, Lithuania, Latvia, assume that x3, x4, x5 and ξi are independent normal variables with
Luxembourg, Poland, Portugal, Slovakia, Slovenia, plus Norway and Switzerland. variance equal to 0.25, then the variance covariance matrix of x1 is
 Author's personal copy

118 J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125

Table 3 Table 5
Effect of the factors and covariates on the β2 bias and RMSE. Analysis of variance with polynomial contrasts for β2 bias and RMSE.

Parameter Bias RMSE Degrees Bias RMSE

of
ρu − 0.03154⁎⁎⁎ 0.07684 ⁎⁎⁎ Mean Variance Mean Variance
freedom
(− 22.50) (54.76) square ratio square ratio
ρx − 0.12025⁎⁎⁎ 0.11186 ⁎⁎⁎
Method 6 57.000746 10695.83⁎⁎⁎ 13.444515 2833.85⁎⁎⁎
(− 85.77) (79.73)
Linear 1 269.898157 50644.70⁎⁎⁎ 63.139644 13,308.64⁎⁎⁎
ρv 0.01365⁎⁎⁎ −0.01220 ⁎⁎
Quadratic 1 34.548532 6482.82⁎⁎⁎ 4.477564 943.79⁎⁎⁎
(6.40) (− 5.71)
Cubic 1 0.123098 23.10⁎⁎⁎ 0.088539 18.66⁎⁎⁎
λ - 0.48178⁎⁎⁎ 0.44238 ⁎⁎⁎
Quartic 1 16.192877 3038.49⁎⁎⁎ 5.973715 1259.15⁎⁎⁎
(− 188.00) (172.49)
Deviations 2 10.620906 1992.95⁎⁎⁎ 3.493814 736.43⁎⁎⁎
n (sample size) 5.993.10− 5⁎⁎⁎ −2.6345.10− 5⁎⁎⁎
ρu 7 0.453893 85.17⁎⁎⁎ 3.149956 663.95⁎⁎⁎
(18.16) (−79.76)
ρx 7 9.719796 1823.86⁎⁎⁎ 8.510049 1793.76⁎⁎⁎
OLS −0.03418⁎⁎⁎ 0.10936⁎⁎⁎
ρv 2 0.126842 23.80⁎⁎⁎ 0.100754 21.24⁎⁎⁎
(−19.53) (62.43)
λ 2 108.973611 20448.22⁎⁎⁎ 91.544049 19295.75⁎⁎⁎
GMM − 0.06932⁎⁎⁎ 0.12813 ⁎⁎⁎
n 3 0.952095 178.65⁎⁎⁎ 16.746282 3529.80⁎⁎⁎
(− 39.60) (73.14)
ML − 0.08751⁎⁎⁎ 0.14585 ⁎⁎⁎
Interactions with levels of method
(− 49.99) (83.26)
n.ml 3 0.007048 1.32 0.492035 103.71⁎⁎⁎
IV_3g − 0.02478⁎⁎⁎ 0.10992⁎⁎⁎
n.gmm 3 0.001696 0.32 0.563503 118.78⁎⁎⁎
(− 14.15) (62.75)
n.iv_gmm_3g 3 0.000251 0.05 0.459010 96.75⁎⁎⁎
IV_x4x5 0.16995⁎⁎⁎ 0.02380 ⁎⁎⁎
n.ols 3 0.006245 1.17 0.420719 88.68⁎⁎⁎
(97.09) (13.59)
n.iv_3g 3 0.011753 2.21⁎ 0.452598 95.40⁎⁎⁎
IVgmm_3g −0.05678⁎⁎⁎ 0.12224⁎⁎⁎
n.ivgmm_x4x5 3 0.000563 0.11 0.065267 13.76⁎⁎⁎
(− 32.44) (69.78)
n.iv_x4x5 3 0.003568 0.67 0.191594 40.38⁎⁎⁎
IVgmm_x4x5 0.16880⁎⁎⁎ 0.00766⁎⁎⁎
Covariate 1 0.000117 0.02 0.030918 6.52⁎⁎
(96.43) (4.37)
queen
queen 0.000120 − 0.001958⁎⁎
Residual 32,206 0.005329 0.004744
(0.14) (−2.25)
Total 32,255
N 32,256 32,256
σ2 0.006120 0.006129 Note: * significant at 10%, ** significant at 5%, *** significant at 1%.
Notes: t-ratio in brackets * significant at 10%, ** significant at 5%, *** significant at 1%.

this case, we also only allow for spatial error autocorrelation

−1 −1
(I − ρxW) (I − ρxW ') . We proxy the variance of x1 by the mean of
the diagonal elements of this variance-variance matrix, denoting this
mean variance by σ 2x1 . Likewise, we have v = (I − ρvW)− 1ζ with ζ → Nid
(0, σζ2). We denote by σ 2 the mean element of (I − ρvW)− 1(I − ρvW')− 1.
Then the variance of v can be proxied by σζ2 :σ 2 . Finally, λ, as a fraction of
the variance of v over the variance of x1 can be proxied by:
λ = σζ2 :σ 2 = σ 2x1 . Hence, in order to generate

v for a given value of λ,
one first needs to compute σζ2 as σζ2 = λ:σ 2x1 =σ 2 . Once σζ2 has been
computed, then we can generate v as: v = (I − ρvW)− 1ζ with ζ → Nid(0,
σζ2).
Each experiment is characterized by given values of ρx, ρu, ρv and
λ = σv2/σx2. We use the following values: n = {49, 121, 225, 400}, ρu =
{0, 0.1, 0.2, 0.3, 0.4, 0.5, 0.8, 0.95}, ρx = {0, 0.1, 0.2, 0.3, 0.4, 0.5, 0.8,
0.95}, ρv = {− 0.25, 0, 0, 25} and λ = {0.1, 0.2, 0.5}. For each
experiment, we perform 1,000 replications. We estimate β in
Eq. (22) using the following methods:
• OLS estimator (OLS). In this case, neither the spatial error
autocorrelation, nor the EIV is taken into account in the estimation.
• GMM estimator (GMM) suggested by Kelejian and Prucha (1999). In
this case, we only allow for the fact that the error terms are spatially
correlated. The EIV is not taken into account.
• ML estimator (ML) as it is widely used in the applied spatial
econometrics literature (Anselin, 1988; Lee, 2004). As previously, in
Table 4
Mean β2 bias and RMSE across methods.
whereas EIV is not taken into account.
• IV estimator with 3-group variable as instruments (IV_3g). This
estimator aims to correct for EIV. The instruments are defined using a
quasi-instrument with values equal to −1, 0, 1 depending on whether
the observed variable (x1 plus measurement error) is in the upper,
middle or lower third of values when placed in rank order. We also use
the spatial lag of this quasi-instrument as an additional instrument.
This instrument is defined following the 3-group method for
measurement errors (Kennedy, 2003). It has been used in a spatial
framework by Fingleton (2003) and its properties have been
investigated in Fingleton and Le Gallo (2008a, 2008b, 2009).
• IV estimator with x4 and x5 as instruments (IV_x4x5). This estimator
corrects for EIV using “optimal” instruments, which are x4 and x5
since x1 depends upon these two variables. Then we can evaluate
how the choice of instruments affects the bias caused by EIV.
• IV estimator with 3-group variable as instruments combined with
GMM (IVgmm_3g) as suggested by Fingleton and Le Gallo (2008a).
Estimation comprises three stages. In the first stage, model (24) is
estimated by IV, using the quasi-instrument and its spatial lag as
above. The second stage uses the resulting consistent 2SLS residuals
to estimate ρu and σ 2 using a GM procedure, with the moments
derived by Kelejian and Prucha (1999). In the third stage, the
estimated ρu is used to perform a Cochrane-Orcutt transformation
to account for the spatial dependence in the residuals. IV estimation
is then performed with the transformed variables.
• IV estimator with x4 and x5 as instruments combined with GMM
(IVgmm_x4x5). This is the same as the previous estimator but in
this case we use the optimal instruments.

Bias RMSE
The weights matrices of increasing sizes are based on the rook and
Grand mean − 0.16871 0.23371 the queen criteria for regular lattices. Moreover they are row-
ML − 0.26568 0.28714 standardized. There are an infinite number of possible W matrices
GMM − 0.24749 0.26941
IVgmm_3g − 0.23495 0.26353
that we could use, so we have to restrict our simulations to a subset,
IV_3g − 0.20294 0.25121 and these two are among the most popular. They are useful because
OLS − 0.21235 0.25065 they are distinguished from each other in terms of the amount of
IV_x4x5 − 0.00822 0.16509 connectivity between places that is assumed, which might have a
IVgmm_x4x5 − 0.00937 0.14894
bearing on the outcome of our simulations, bearing in mind that the
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J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125 119

properties of many estimators depend on the density of connectivity Table 6

of the W matrix (see for instance Baltagi and Liu, 2009; Farber et al., Analysis of variance contrasts for β2 bias and RMSE.

2009; Smith, 2009; Stakhovych and Bijmolt, 2009). A fuller appraisal Degrees Bias RMSE
of the impact of network density and of the importance of lattice of
Mean Variance Mean Variance
regularity is beyond the scope of the current paper, but is something freedom
square ratio square ratio
that could be considered in future work.
Method 6 57.000746 10,695.83⁎⁎⁎ 13.444515 2833.85⁎⁎⁎
Error model versus 1 18.354680 3444.14 ⁎⁎⁎ 3.140340 661.92 ⁎⁎⁎
6. Results no error model
deviations 5 64.729959 12,146.17⁎⁎⁎ 15.505350 3268.23 ⁎⁎⁎
First, as a benchmark case, we have produced simulations results Residual 32,206 0.005329 0.004744
Total 32,255
when no measurement errors are present in the DGP, focusing on
parameter bias and RMSE. Bias is equal to the median of the estimated Note: * significant at 10%, ** significant at 5%, *** significant at 1%. The results for the
covariates are equal to those reported in Table 4.
parameter distribution minus the true value. However, attention should
also focus on the RMSE, which gives equal weight to the two important
measurement error, given that Dagenais (1994) found that in the time
considerations for optimal estimation, bias and dispersion. In other words,
series case the standard approach of controlling for serial correlation in
we have analyzed the bias and RMSE in β2 for the following model:
disturbances performed relatively worse than OLS.
yi = β1 + β2 xi1 + β3 xi2 + ui with i = 1…n ð23aÞ The results given in Table 3 show a clear distinction between the
estimators based on the optimal instruments, namely IV_x4x5 and
ui = ρu ∑ wij uj + εi ð23bÞ IVgmm_x4x5, and the other estimators. Our two optimal instruments
j≠i estimators have minimal bias and by far the lowest RMSE compared
with the other estimators, and this is the case regardless of whether
x1i = ρx ∑ wij x1j + ξi ð23cÞ error autocorrelation is ignored, as in the case of IV_x4x5, or modeled
j≠i
as in the case of IVgmm_x4x5. Ostensibly, this outcome is contrary to
what one would anticipate from the analogous Dagenais time series
with the same values as before for the simulation: n = 49, 121, 225,
result. However, a more realistic situation is the case in which we do
400, ρu = {0, 0.1, 0.2, 0.3, 0.4, 0.5, 0.8, 0.95}, ρx = {0, 0.1, 0.2, 0.3, 0.4,
not know the optimal instruments.
0.5, 0.8, 0.95}. Eq. (23a) has been estimated using OLS, GMM and ML.
If we consider the remaining 5 estimators, we do find that there is
The mean β2 bias when Eq. (23a) is estimated by OLS is − 1.2.10 − 5
a larger more negative bias and larger RMSE when one allows for
whereas it is equal to −1.2.10 − 4 (−2.7.10 − 5) when GMM (resp. ML)
residual autocorrelation by means of the ‘ML’, ‘GMM’ and ‘IVgmm_3g’
are used. This difference is not statistically significant. This is as
estimators than occurs via simply using the OLS or IV_3g estimators.
expected because it is well known that the presence of spatial error
The ‘ML’ estimator leads to even a larger negative bias than ‘GMM’ and
autocorrelation leaves OLS estimators unbiased. However, it does
‘IVgmm_3g’. This would indicate that the conclusion made by
affect the efficiency of the estimator, with the outcome that the mean
Dagenais that controlling for residual serial dependence is sub-
β2 RMSE is 0.114 under OLS compared with 0.083 (resp. 0.084) with
optimal in the presence of measurement error also carries over to the
GMM (resp. ML). This is a statistically significant difference.
spatial case with non-optimal instruments. In terms of RMSE, there
We turn now to the case where measurement error is present. One
appears to be no difference between ‘IV_3g’ and ‘OLS’, even though
consequence of our experimental design is that the Monte Carlo exercise
IV_3g seems to produce slightly less bias.
produces large multi-dimensional arrays of data. We obtain data showing
This is apparent simply from the means for each estimator, which are
the bias and RMSE in β26 for each of the 4,032 cases, and analyzing 4
listed in Table 4. Moreover, comparing these figures to the ones obtained
sample sizes and 2 weights matrices this gives 32,256 cases in total.
for the benchmark case (Eqs. (23a), (23b), (23c)) makes the attenuation
Our initial exploratory analysis is aimed at highlighting the significance
bias affecting β2 quite apparent while the detrimental effect on RMSE is
and direction of the effects of our variables. We use OLS to perform these
also evident.
regressions,7 treating each ‘ρu’, ‘ρx’, ‘ρv’, ‘λ’ and sample size ‘n’ as a variate
In order to capture the essential sources of variation in our large
with values as given earlier, and ‘queen’ as a dummy variable, equal to 1
array of results in more detail, we next subject the data to an analysis
when the W matrix is based on the queen's case and equal to 0 when it is
of covariance 8 (ANCOVA) in which there are two responses, ‘bias’ and
based on the rook's case. Each estimation method is also a dummy
‘RMSE’, six factors, namely ‘method’, ‘ρu’, ‘ρx’, ‘ρv’, ‘λ’ and sample size
variable, with the constant omitted from the model to identify each one.
‘n’, and one covariate, ‘queen’. Factor ‘method’ has seven levels,
The results are provided in Table 3. With such a large sample size,
corresponding to the seven estimation methods and described above.
each effect is highly significant, but we can still see large differences
The factors ‘ρu’, ‘ρx’, ‘ρv’, ‘λ’ have 8, 8, 3 and 3 levels respectively, the
between them. The most prominent effect on both bias and RMSE is due
values of which are as designated above. The sample size has four
to λ, which has a negative effect on bias and a positive effect on RMSE.
levels according to whether the matrix is 7 by 7 and so on up to a 20 by
The effect of sample size is mixed and the structure of connectivity of the
20 matrix. The covariate ‘queen’ is a dummy variable.
W matrix does not impact the bias of the estimators although it has an
We show how the bias and RMSE changes as we move through the
effect on RMSE. However, we focus here on the effect of the 7 different
different levels of ‘method’, going from ML (level 1) to GMM (2),
estimators, ‘OLS’, ‘GMM’, ‘ML’, ‘IV_3g’, ‘IV_x4x5’, ‘IVgmm_3g’ and
IVgmm_3g (3), OLS (4), IV_3g (5), IVgmm_x4x5 (6) and finally
‘IVgmm_x4x5’, since we are principally interested in whether or not it
IV_x4x5 (7), by fitting linear, quadratic, cubic and finally polynomial
is necessary to control for spatial dependence in the presence of
of degree 4 (quartic) contrasts to these data. 9 For each contrast, a
mean square is obtained equal to its sum of squares divided by the
number of degrees of freedom. Each mean square is divided by the
6
In this paper, we only present the effect of EIV on the estimate of β2. We have also residual mean square and the resulting variance ratios are referred to
analyzed the properties of the estimators of β1 and β3 but no evidence of
contamination bias was found in our setup.
the relevant F distribution. These are displayed in Table 5.
7
For a smaller subset of our data, we have also obtained robust estimates using 8
8
different weighting functions, and the default tuning constants suggested by the See Griffith and Paelinck (2007) for a Regional Science application of ANCOVA in
MATLAB documentation. On the whole the results are very similar to those obtained another context.
9
by OLS, although in general the robust means tend to be less extreme that the OLS We do not consider higher order orthogonal polynomials. Their effect is given
estimates. Details are available on request. under ‘deviations’ in Table 5.
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120 J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125

Fig. 1. Bias and RMSE as a function of β2 in function of λ; n = 400; ρv = 0; ρu = 0.5; ρx = 0.5.

Fig. 2. Bias and RMSE as a function of β2 in function of λ; n = 400; ρv = 0; ρu = 0.5; ρx = 0.8.

Table 5 highlights the fact that the there is an overwhelmingly linear
trend in bias and RMSE as one goes through the sequence ML, GMM,
IVgmm_3g, OLS, IV_3g, IVgmm_x4x5 and finally IV_x4x5. We find that
as level increases, bias and RMSE diminish systematically, with the two
optimal instrument estimators at the highest level. That these trends
are strongly but not perfectly linear is shown by plotting mean bias and
RMSE against level, and by the statistically significant nonlinear
contrasts. 10 An additional element in Table 5 is the presence of
interactions between sample size and individual estimation methods.
With regard to bias, we see almost no significant interactions. There are
10
The orthogonal polynomial coefficients used to make the linear, quadratic, cubic
and quartic contrasts are given, for example, in the Table on page 272, Draper and
Smith (1981) or Wetherill (1981), Table C.11.
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J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125 121

Fig. 3. Bias and RMSE as a function of β2 in function of λ; n = 400; ρv = 0; ρu = 0.8; ρx = 0.5.

Fig. 4. Bias and RMSE as a function of β2 in function of λ; n = 400; ρv = 0; ρu = 0.8; ρx = 0.8.

statistically significant interactions between estimation method and
sample size when one considers the RMSE results, but these effects are
relatively small when one compares variance ratios, and are of little
empirical significance. Likewise, the effect of W matrix connectivity, as
represented by the covariate ‘queen’, is insignificant in the case of bias,
and evidently very small in the case of RMSE.
Using ANCOVA to explicitly test whether modeling the error process
increases bias and RMSE, the treatment structure for error process
model versus no error process model is −0.25, −0.25, −0.25, 0.333,
0.333, −0.25, 0.333, thus given equal weight to the various estimation
methods. It is evident from Table 6 that attempting to control for error
dependence produces significantly more negative bias and a higher
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122 J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125

Table 7
Analysis of covariance for β2 bias and RMSE.

Source of Degrees Bias RMSE

variation of
Mean square Variance ratio Mean square Variance ratio
freedom

Method 6 57 97,621.34 ⁎⁎⁎ 13.44 23,653.43⁎⁎⁎

λ 2 109 186,600 ⁎⁎⁎ 91.54 161,100⁎⁎⁎
ρx 7 9.720 16,646.44 ⁎⁎⁎ 8.510 14,972.04⁎⁎⁎
ρu 7 0.4539 777.35 ⁎⁎⁎ 3.150 5541.83⁎⁎⁎
ρv 2 0.1268 217.23 ⁎⁎⁎ 0.1008 177.26⁎⁎⁎
method. λ 12 6.407 10,972.05 ⁎⁎⁎ 4.403 7746.24⁎⁎⁎
method. ρx 42 1.194 2045.07 ⁎⁎⁎ 1.177 2070.07⁎⁎⁎
λ.ρx 14 0.5146 881.40 ⁎⁎⁎ 0.6792 1194.87⁎⁎⁎
method. ρu 42 0.0898 153.79 ⁎⁎⁎ 0.1339 235.51⁎⁎⁎
λ.ρu 14 9.360.10− 4 1.60 ⁎ 0.02830 49.78⁎⁎⁎
method. ρv 12 0.03107 53.21 ⁎⁎⁎ 0.03189 56.10⁎⁎⁎
λ.ρv 4 8.854.10− 3 15.16 ⁎⁎⁎ 0.01011 17.78⁎⁎⁎
ρx. ρu 49 0.08701 149.02 ⁎⁎⁎ 0.09940 174.87⁎⁎⁎
ρu. ρv 14 0.02512 43.03 ⁎⁎⁎ 0.01903 33.48⁎⁎⁎
ρxρv 14 3.606.10− 3 6.18 ⁎⁎⁎ 2.699.10− 3 4.75⁎⁎⁎
method. λ.ρx 84 0.05202 89.09 ⁎⁎⁎ 0.04794 84.34⁎⁎⁎
method. λ.ρu 84 7.541.10− 4 1.29 ⁎⁎ 0.01464 25.75⁎⁎⁎
method. λ.ρv 24 1.928.10− 3 3.30 ⁎⁎⁎ 2.150.10− 3 3.78⁎⁎⁎
method. ρx. ρu 294 0.01621 27.77 ⁎⁎⁎ 0.01792 31.53⁎⁎⁎
method. ρu.ρv 84 4.372.10− 3 7.49 ⁎⁎⁎ 4.291.10− 3 7.55⁎⁎⁎
method. ρx. ρv 84 2.977.10− 3 5.10 ⁎⁎⁎ 2.698.10− 3 4.75⁎⁎⁎
λ.ρx. ρu 98 4.726.10− 3 8.09 ⁎⁎⁎ 5.282.10− 3 9.29⁎⁎⁎
λ.ρu.ρv 28 7.638.10− 4 1.31 8.261.10− 4 1.45⁎
λ.ρx. ρv 28 4.348.10− 4 0.74 4.441.10− 4 0.78
ρx.ρu. ρv 98 3.015.10− 4 0.52 3.242.10− 4 0.57
n 3 9.521E-01 1630.59⁎⁎⁎ 1.675E + 01 29462.34⁎⁎⁎

Interactions with levels of method

n.ml 3 7.04810− 3 12.07⁎⁎⁎ 0.4920 865.66⁎⁎⁎
n.gmm 3 1.69610− 3 2.90⁎⁎ 0.5635 991.39⁎⁎⁎
n.iv_gmm_3g 3 2.50910− 4 0.43 0.4590 807.55⁎⁎⁎
n.ols 3 6.24510− 3 10.69⁎⁎⁎ 0.4207 740.19⁎⁎⁎
n.iv_3g 3 0.01175 20.13⁎⁎⁎ 0.4526 796.27⁎⁎⁎
n.ivgmm_x4x5 3 5.63310− 4 0.96 0.06527 114.83⁎⁎⁎
n.iv_x4x5 3 3.56810− 3 6.11⁎⁎⁎ 0.1916 337.08⁎⁎⁎
Covariate Queen 1 1.16810− 4 0.20 0.03092 54.39⁎⁎⁎
Residual 31083 5.83910− 4 5.68410− 4
Total 32,255

Note: * significant at 10%, ** significant at 5%, *** significant at 1%.

RMSE than ignoring error dependence, thus reaffirming the main point
of this paper.
To summarize, and focusing on the non-optimal instrument
estimators, the tables indicate that there is a hierarchy in terms of
both bias and RMSE regardless of the value of λ. For instance, in terms of
bias, ML has the largest effect, so that the negative bias associated with
ML is greater than that of other estimators, and the negative bias for
IV_3g is the least, the order being ML b GMM b IVgmm_3g b OLS b IV_3g.
In terms of RMSE, the order is: MLb GMM b IVgmm_3g b IV_3gb OLS.
Thus in terms of our preferred RMSE measure, OLS turns out to be the
best estimator, despite the presence of error dependence. Of course,
our best estimators are IVgmm_x4x5 and IV_x4x5, but these require
knowledge of the optimal estimators, which are rarely if ever
known. Secondly, the bias in β2 always increases (becomes more
negative) with λ and this also causes the RMSE in β2 to also increase
with λ.
Let us next consider interaction effects in more detail. These are
first illustrated graphically in Figs. 1 to 4. These figures display the bias
and RMSE in β2 as a function of λ for n = 400, ρv = 0, ρu = {0.5, 0.8},
ρx = {0.5, 0.8}. With regard to the order described above, it is
maintained, but the differences between the estimation methods
(OLS and IV_3g on the one hand and ML, GMM and IVgmm_3g on the
other hand) increase with λ. In addition the differences between
estimation methods also increase with ρx and ρu. Finally, the stand-
out feature of this and other graphs is the far superior performance of
the optimal instrument estimators. However we focus attention on
the other estimators, which the applied worker is more likely to use in
practice.
The statistical significance of these interactions is evident from
fitting ANCOVA models involving three-way and lower order in-
teractions based on the six factors plus the covariate. Given six factors,
there are in principle 6 one-way effects, 15 two-way effects, and 20
three-way effects, but in order to keep the analysis and table
manageable, we restrict interactions involving sample size ‘n’ to the
individual levels of ‘method’. This gives 10 two-way effects, 10 three-
way effects excluding ‘n’, and in addition we have another 7 two-way
effects involving ‘n’. These are shown in Table 7, which gives the
outcomes for β2 bias and RMSE.
The large sample means that we detect significance in almost all
cases, so we compare the relative sizes of the variance ratios in order
to obtain a measure of relative significance of each interaction. This
indicates that the main effects have a significant effect on bias, but the
covariate ‘queen’ is statistically insignificant even with such a large
sample. Of the two-way effects, the interaction between ‘method’ and
λ stands out prominently. We see that the increasingly negative bias
as λ increases differs according to the estimation method with a
widening gap in the bias incurred under estimation methods that
include error dependence modeling (‘ML’, ‘GMM’ and ‘IVgmm_3g’)
and the better performing OLS and IV_3g methods. Comparing this
with the corresponding panel in Fig. 2 (or equivalently comparing
 Author's personal copy
J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125
Fig. 5. Bias and RMSE as a function of β2 in function of λ; n = 400; ρv = 0; ρu = 0.5; ρx = 0.
Figs. 3 and 4) illustrates the significant there-way interaction
involving ‘method’, λ and ρx, denoted by method.λ.ρx in Table 7.
Hence, the effect of λ on the impact of ‘method’ on bias itself changes
according to ρx. As shown by Table 7, the interaction between
‘method’ and λ barely changes according to ρv or according to ρu. Most
of the three-way interactions involving ρv are either comparatively
weak or not significant.
Table 7 also gives the results of fitting the three-way interaction
model to the RMSE data for β2. This shows that all of the one-way
and two-way effects are significant, with the ‘method’ and λ
interaction again prominent. The ‘method’ and λ interaction is
illustrated by the right hand side panel of Fig. 1. Here, we see that
RMSE depends on method, but RMSE increases with increasing λ,
once again with a widening gap between the error dependence
modeling methods and OLS and IV_3g. The most prominent three-
way interaction involving λ, ‘method’ and ρx (denoted by the
method. λ.ρx term in Table 7) is illustrated by comparing the right
hand side panels of Figs. 1 and 2 (or equivalent the panels of Figs. 3
and 4). This shows that as we move to a higher level of ρx, the effect
of λ on the ‘method’ effect changes. Comparing the right hand side
panels of Figs. 1 and 3 illustrates the λ, ‘method’ and ρuinteraction
(method.λ.ρu). The same effect can be seen by comparing the right
hand side panels of Figs. 2 and 4.
With regard to the effect of ‘n’ and its interaction with the levels of
‘method’, we see that for bias they are relatively weak or insignificant,
although the main effect of ‘n’ is very strong, with bias becoming less
as sample size increases. Likewise the impact of sample size on RMSE
is very strong, with falling RMSE as sample size increases from 49
through to 400. There are also significant interactions involving ‘n’ and
123
the ‘method’ levels in the case of RMSE. For example for OLS, at small
sample sizes RMSE is smaller with OLS estimation than otherwise, but
with large samples the RMSE is smaller for non-OLS estimation.
Finally, spatial connectivity has a significant effect on RMSE, with
increasing connectivity (the ‘queen’ case W matrix) causing a
reduction in RMSE.
Finally, consider Figs. 5 and 6, which are the outcomes when we
restrict the spatial autocorrelation in the explanatory variable to
zero. While the superior performance of the optimal instruments
remains in evidence, it is difficult to see how one might choose any
one of the other instruments in preference to the others. This
reinforces the point that OLS and IVgmm, which make no allowance
for spatial error dependence, outperform the estimators provided
the regressor is spatially autocorrelated. However, as illustrate in
our empirical example, this is very likely to be the case across
a range of applications typically considered by the applied spatial
econometrician.
7. Conclusions
The aim of this paper is to analyze the effects of measurement error
on estimator bias and RMSE in a spatial context. Previously, Fingleton
and Le Gallo (2008a, 2008b) considered endogeneity stemming from
omitted variables or as a consequence of simultaneity, and LeSage and
Pace (2009) analyzed the case of spatially autocorrelated omitted
variables, but up to this point in time the relative performance of
various estimators in the presence of measurement errors in spatial
data has not been explored.
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124 J. Le Gallo, B. Fingleton / Regional Science and Urban Economics 42 (2012) 114–125
Fig. 6. Bias and RMSE as a function of β2 in function of λ; n = 400; ρv = 0; ρu = 0.8; ρx = 0.
Our point of departure is the time series oriented paper by
Dagenais who shows that in some circumstances, given the presence
of serially correlated errors, OLS proves superior to standard
techniques used to correct for serial correlation. In this paper, we
consider the parallel case of cross-sectional regression models. Our
data generating process introduces measurement error into a
(spatially dependent) explanatory variable, and we also introduce
spatial dependence into the measurement errors and the distur-
bances. We compare the properties of various estimators, which do
and do not control for spatially dependent disturbances using Monte-
Carlo simulation. In the case of OLS there is no attempt to allow for the
spatially dependent disturbances and no control for endogeneity
introduced by EIV. In the case of IV_3g we control for EIV using
instrumental variables, but do not allow for the disturbance process.
Our GMM estimators and our ML estimator allow for spatially
dependent disturbances, and in the case of IVgmm_3g we also
instrument the variable with measurement error. We also consider
estimators based on optimal instruments, which will usually be
unknown. These perform far better than the other estimators both in
terms of bias and RMSE, regardless of whether we control for error
dependence (IVgmm_x4x5) or not (IV_x4x5).
For our non-optimal instrument estimators (which is what the
applied researcher will typically be working with), simulation results
show that coefficient estimation bias for the mismeasured variable
becomes increasingly negative with increasingly positive spatial
dependence in the disturbances. Bias also becomes more negative as
the ratio of measurement error variance to explanatory variable
variance augments. We find that OLS and IV_3g estimation outper-
form GMM-based and ML estimation, a conclusion that is reinforced
(at least for small samples) when one also takes account of the
precision of the estimates via RMSE. These results, like those of
Dagenais (1994) in the time series context, indicate that measure-
ment error plus a disturbance process involving spatial dependence is,
somewhat paradoxically, best accommodated by an estimation
method that ignores the spatial dependence.
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