The Sensitivity of Labor Supply Parameter Estimates to Unobserved Individual Effects: Fixed and Random Effects Estimates in a Nonlinear Model Using Panel Data

Abstract

A life cycle model of labor supply predicts the presence of an unobserved individual effect (log marginal utility of wealth) in the labor supply equation which is correlated with the observed explanatory variables, leading to an omitted variables bias in the cross section. We examine the sensitivity of parameter estimates to the presence of unobserved individual effects, using both fixed- and random effect Tobit models. The estimated effects of children are biased away from zero in the cross section. The estimated intertemporal substitution elasticity ranges from 1.1 to 1.7. The results are similar for both fixed and random effects models, and for models using log leisure and hours of work as the dependent variable.