Murphy-Topel Adjustment of the Variance-Covariance Matrix of a Two-Step Panel Data Model: Evidence from Competition-Fragility Nexus in Banking

We develop the Murphy-Topel adjustment of the variance-covariance matrix for two-step panel data models. We apply it on the competition-fragility nexus in banking with different samples for two equations. Indeed, this issue is often observed in this field of research. A competition measure of banks is constructed for each country (first equation), whereas a risk measure is regressed on the entire sample of countries (second equation). Any statistical adjustment will only provide approximate results for the second equation, because of possible correlations between the results of both models. The Murphy-Topel method eventually seems to be more appropriate.