Clustered standard errors are a way to obtain unbiased standard errors of OLS coefficients under a specific kind of heteroscedasticity. Recall that the presence of heteroscedasticity violates the Gauss Markov assumptions that are necessary to render OLS the best linear unbiased estimator (BLUE).

The estimation of clustered standard errors is justified if there are several different covariance structures within your data sample that vary by a certain characteristic – a “cluster”. Furthermore, the covariance structures must be homoskedastic within each cluster. In this case clustered standard errors provide unbiased standard errors estimates. Continue reading