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# Watch Out for These Things When Using Time-Varying Regressors in Difference in Differences

Posted March 15, 2022 by Brant Callaway ‐ 12 min read

In this post, Brant Callaway from the University of Georgia explains why time-varying covariates might pose a problem in TWFE and what steps you can take to avoid them. ## Introduction

My colleague Carol Caetano, and two UGA grad students Hugo Sant&rsquo;Anna Rodrigues and Stroud Payne just posted a new working paper about DID with time varying covariates. This is a topic that has been in the back of my mind for a long time — and I get a lot of questions about time varying covariates from people using the <code>did</code> package.

My sense has been there are perhaps a number of limitations to the sorts of two way fixed effects (TWFE) regressions that include covariates that are very common in applied work. And, in particular, that there could be distinct issues from those that show up in the literature on TWFE regressions with multiple periods and variation in treatment timing (e.g., Goodman-Bacon (2021), de Chaisemartin and d&rsquo;Haultfoeuille (2020), and Borusyak, Jaravel, and Spiess (2021))

In this paper, we have worked out a lot of these issues – particularly, in the case with exactly two time periods (which is a case where TWFE regressions work well under unconditional parallel trends). We also provide alternative strategies that (i) are able to get around these issues and (ii) are only slightly more complicated to implement than TWFE regressions.

## TWFE Regressions

To fix ideas, let me write down how most researchers implement DID identification strategies when they think that the underlying parallel trends assumption ought to be conditional on some covariates:

$$\begin{equation*} Y_{it} = \theta_t + \eta_i + \alpha D_{it} + X_{it}'\beta + v_{it} \end{equation*}$$

where $Y_{it}$ is the outcome of interest (for unit $i$ in time period $t$), $\theta_t$ is a time fixed effect, $\eta_i$ is an individual fixed effect, $D_{it}$ is a treatment dummy variable, $\alpha$ is what will be reported as *the* causal effect of the treatment (or, maybe loosely as some kind of average causal effect), $X_{it}$ are the time-varying covariates, and $v_{it}$ are idiosyncratic time-varying unobservables. We show that there are a number of potential limitations with using this two-way fixed effects (TWFE) regression:

1. In cases with multiple periods and variation in treatment timing, this sort of TWFE regression uses already treated units as the comparison group, and therefore suffers from all well-known weaknesses in this case. Both Goodman-Bacon (2021) and de Chaisemartin and d’Haultfoeuille (2020) already have results along these lines, so I’m going to only talk about the case with two time periods below (which is a case where, at least in the case of unconditional parallel trends, TWFE regressions work fine).

2. TWFE regressions won’t work well if the time-varying covariates are affected by the treatment. This issue is often referred to as a “bad control” problem. It seems to be standard practice just not to include covariates that are potentially affected by the treatment. I agree that it’s a bad idea to include a time-varying covariate that is itself affected by the treatment, but I am less sure that a good solution is to just not include it.

For example, suppose that a labor economist is studying the effect of a treatment on a person’s earnings and thinks parallel trends holds after conditioning on a person’s occupation, but occupation is potentially affected by the treatment (there is tons of work in labor economics that would be concerned with this issue). Both ignoring occupation and including occupation run into issues. One helpful way to think about this is to try to condition on untreated potential occupation — that is, what occupation would have occurred if a person had not been treated. TWFE regressions don’t naturally accommodate this, but we propose some solutions for this case (I’ll come back to this below).

3. TWFE regressions like this are highly sensitive to the functional form. Since we are considering the case with two periods (and, like the “textbook” version of DID, where no units are treated yet in the first period), we can write

$$\begin{equation*} \Delta Y_{it^*} = (\theta_{t^*} - \theta_{t^*-1}) + \alpha D_i + \Delta X_{it^*} \beta + \Delta v_{it^*} \end{equation*}$$

where $t^*$ indicates the second time period. You can see from this specification that, due to our linear functional form for the levels, we are effectively only controlling for the change in covariates over time.

We show that TWFE regressions implicitly rely on (i) the conditional parallel trends assumption only depending on the change in the time-varying covariates over time, and (ii) similarly, that TWFE regressions rely on conditional ATTs only depending on changes in time-covariates over time. Thus, TWFE can perform poorly in cases where, for example, the path of untreated potential outcomes also depends on the level of the time-varying covariate.

Let me give you a concrete example where only controlling for changes in covariates seems undesirable. Suppose you are using county-level data and are studying the effect of a treatment in Georgia using counties from Tennessee as the comparison group, and that you think that parallel trends holds after you condition on county population. I live in Oconee County, Georgia. From 2010 to 2021 (which were the dates I could most easily find for county population), Oconee County grew from about 33,000 to about 42,000. In Tennessee, the county with the most similar population change was Sevier County which increased from about 90,000 to about 99,000. But Sevier County is more than twice as big as Oconee County. This is probably not what we had in mind when we said we wanted to condition on county population. Maybe this is just bad luck, let’s check the county with the next most similar population change. It is Shelby County — this is Memphis! — which increased from 928,500 to 938,800. I don’t think anyone would think that comparing paths of outcomes for Shelby County and Oconee County is what any researcher has in mind for DID conditioning on county population. As a side-comment, if you switch to, say, the change in log population over time, you do not do much better either — in that case, the closest match is Montgomery County, TN which has over 5 times the population of Oconee County.

Perhaps somewhat surprisingly TWFE regressions also require strong functional form assumptions on the propensity score (see paper for details).

4. Similarly, we show that TWFE regressions are not robust to parallel trends assumptions and conditional ATTs depending on time-invariant covariates. However, conditioning on time-invariant covariates in the parallel trends assumption is important in many applications. For example, if you are a labor economist studying the effect of some treatment on people’s earnings, the most important covariates to condition on in the parallel trends assumption are all likely to be time invariant — e.g., demographics, education, etc.

5. $\alpha$ is hard to interpret in the presence of treatment effect heterogeneity. Even if none of the issues above apply in a particular application, if treatment effects are heterogeneous (particularly, if they can vary across different values of the covariates), (under some additional conditions) $\alpha$ will be equal to a weighted average of conditional ATT parameters but they will suffer from the “weight reversal” property pointed out in Sloczynski (2020) in a different context — conditional ATTs for values of the covariates that are uncommon for the treated group relative to the untreated group get lots of weight, and the opposite happens for relatively common values of the covariates.

If a researcher is fortunate enough that none of these issues apply in their application, then a TWFE regression would recover the ATT.

## Existing Work in Econometrics

Most work on DID under conditional parallel trends (e.g., Abadie (2005), Sant&rsquo;Anna and Zhao (2020), and Chang (2020)) considers the case with time-invariant covariates or uses “pre-treatment” values of time-varying covariates (which effectively just makes time-varying covariates time invariant by using their value in the pre-treatment period). This already solves most of the above issues: they can be adapted to handle cases multiple periods and variation in treatment timing in (1), they do not require the same strong functional form assumptions as in (3), they solve (4) above because they include time-invariant covariates, and they recover the overall ATT directly rather than a hard-to-interpret weighted average of conditional ATTs as in (5).

## What’s New in our Paper

1. First, in order to address (2), where the time-varying covariates could themselves be affected by the treatment, we provide specific conditions under which it is sufficient to condition on pre-treatment values of the time-varying covariates as is common in the econometrics literature. In particular, the condition that rationalizes conditioning on pre-treatment covariates is

$$\begin{equation*} X_{t^*}(0) \perp D | X_{t^*-1}, Z \end{equation*}$$

where $X_{t^*}(0)$ is the value that $X$ would take in time period $t^*$ if the treatment had not occurred and $Z$ is the vector of time-invariant covariates in the parallel trends assumption. This is an unconfoundedness assumption, but for time-varying covariates rather than the outcome. In words, it says that covariates are evolving similarly among treated and untreated units that have the same pre-treatment characteristics $X_{t^*-1}$ and time-invariant covariates $Z$.

This condition may or may not be reasonable in particular applications, but it is the sort of thing that reseachers ought to think about. It is also “pre-testable” (i.e., you can look at data in pre-treatment periods and potentially find evidence for or against it).

In cases where this assumption does not hold, the strategy of just conditioning on pre-treatment covariates does not generally work. But we consider a number of other possible assumptions that can lead to alternative identification arguments in the paper. A big part of the paper is about these cases, but it is perhaps best just to consult the paper itself on this front as these arguments are somewhat more complicated.

2. Another important case is when a researcher is confident that covariates are evolving exogenously from the treatment; a simple version of this is just where $X_{it^*}(1) = X_{it^*}(0)$ for all units (that is, the value of the covariates is the same under the treatment as without the treatment). Ignoring the issue of time-invariant covariates, the main issue with TWFE in this case are the functional form issues pointed out in (3) above. In this case, we provide a doubly robust expression for that ATT that does not rely on those sorts of functional form assumptions. These expressions involve outcome regressions and propensity scores that depend on both $X_{t^*}$ and $X_{t^*-1}$ — these can be challenging to estimate well because $X_{t^*}$ and $X_{t^*-1}$ are likely to be highly collinear in many applications. However, the doubly robust expression for the ATT allows us to connect to the literature on DID with machine learning (Chang (2020)) which provides an attractive way to try to estimate these functions.

3. Finally, in cases where these kinds of doubly robust / machine learning approaches are more complicated than a researcher actually wants to implement, we provide strategies for all of the cases discussed above that can be implemented using just regressions and averaging. Relative to the previous two points, these approaches require additional linearity assumptions (though substantially less restrictive than the issues discussed earlier for TWFE regressions), but have the benefit of being easier to implement; these ideas build on the ideas of regression adjustment and imputation that have shown up recently in the DID literature (Liu, Wang, and Xu (2021), Gardner (2021), Borusyak, Jaravel, and Spiess (2021)).

Let me just give the example of what we propose to do in cases where the time-varying covariates evolve exogenously. Similar to the “imputation” literature, we can exploit the connection between parallel trends assumptions and a model for untreated potential outcomes:

$$\begin{equation*} Y_{it}(0) = Z_i'\delta_t + \eta_i + X_{it}(0) \beta_t + v_{it} \end{equation*}$$

where we take $Z$ to include an intercept. The $\beta_t$ is perhaps non-standard (see discussion in next paragraph). Taking the difference over time implies

$$\begin{equation*} \Delta Y_{it^*}(0) = Z_i'\delta^*_{t^*} + \Delta X_{it^*}(0) \beta_{t^*} + X_{it^*-1}(0) \beta^*_{t^*} + \Delta v_{it^*} \end{equation*}$$

where we define

$$\begin{equation*} \delta^*_{t^*} := (\delta_{t^*} - \delta_{t^*-1})) \end{equation*}$$

and

$$\begin{equation*} \beta^*_{t^*} := (\beta_{t^*} - \beta_{t^*-1})). \end{equation*}$$

In my view, this is particularly attractive specification for untreated potential outcomes in terms of time-varying covariates. It “pre-treatment” value of the covariate) as well as the change in covariates over time. And, for example, (up to the parametric assumptions) this expression would avoid the issues of comparing counties with similar changes in population over time but very dissimilar overall populations.

Moreover, since we observe untreated potential outcomes and covariates for the untreated group, we can recover all of the parameters from the regression of $\Delta Y_{t^*}$ on $Z$, $\Delta X_{t^*}$, and $X_{t^*-1}$ using the untreated group. Next, notice that

$$\begin{equation*} ATT = \mathbb{E}[\Delta Y_{t^*} | D=1] - \mathbb{E}[\Delta Y_{t^*}(0) | D=1] \end{equation*}$$

$$\begin{equation*} = \mathbb{E}[\Delta Y_{t^*} | D=1] - \Big(\mathbb{E}[Z|D=1]'\delta^*_{t^*} + \mathbb{E}[\Delta X_{t^*}(0) | D=1] \beta_{t^*} + \mathbb{E}[X_{t^*-1}|D=1]\beta^*_{t^*} \Big) \end{equation*}$$

where the second equality holds by plugging in the expression for $\Delta Y_{t^*}(0)$ from the previous display. Everything is identified in the last line except for $\E[\Delta X_{t^*}(0) | D=1]$. If we believe that covariates evolve exogenously though, it means that this term is equal to $\E[\Delta X_{t^*} | D=1]$ which is identified. We consider 5 additional scenarios for recovering $\E[\Delta X_{t^*}(0) | D=1]$ in the paper.

To summarize, this suggests a simple two-step estimation procedure: (i) estimate a regression using untreated observations and recover the estimates of the parameters in the model for untreated potential outcomes, (ii) combine these with estimates of the averages of the change in outcomes over time and averages of covariates for the treated group (as in the previous display) to compute the ATT.

## Conclusion

In my view, the sorts of TWFE regressions that show up in many applications in economics have a number of limitations – when these TWFE regressions include time-varying covariates, we are arguing that they are likely to have a number of disadvantages even in “textbook” cases with only two time periods. Fortunately, it is quite straightforward to use other approaches (that are not much more complicated) that can essentially avoid all of these issues.

We don’t have code yet, but we are working on it. If you have comments/questions, please feel free to get in touch.

• Abadie, Alberto. “Semiparametric difference-in-differences estimators.” The Review of Economic Studies 72.1 (2005): 1-19.

• Borusyak, Kirill, Xavier Jaravel, and Jann Spiess. “Revisiting event study designs: Robust and efficient estimation.” arXiv preprint arXiv:2108.12419 (2021).

• Chang, Neng-Chieh. “Double/debiased machine learning for difference-in-differences models.” The Econometrics Journal 23.2 (2020): 177-191.

• de Chaisemartin, Clément, and Xavier d’Haultfoeuille. “Two-way fixed effects estimators with heterogeneous treatment effects.” American Economic Review 110.9 (2020): 2964-96.

• Gardner, John. “Two-stage differences in differences.” (2021).

• Goodman-Bacon, Andrew. “Difference-in-differences with variation in treatment timing.” Journal of Econometrics (2021).

• Liu, Licheng, Ye Wang, and Yiqing Xu. “A practical guide to counterfactual estimators for causal inference with time-series cross-sectional data.” arXiv preprint arXiv:2107.00856 (2021).

• Sant’Anna, Pedro HC, and Jun Zhao. “Doubly robust difference-in-differences estimators.” Journal of Econometrics 219.1 (2020): 101-122.

• Słoczyński, Tymon. “Interpreting ols estimands when treatment effects are heterogeneous: Smaller groups get larger weights.” The Review of Economics and Statistics (2020): 1-27.

###### Tags
Instrumental Variables, Difference-in-Differences, Policy-Evaluation, TWFE Regressions