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General Diagnostic Tests for Cross Section Dependence in Panels

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  • Pesaran, M. Hashem

    ()
    (University of Cambridge)

Abstract

This paper proposes simple tests of error cross section dependence which are applicable to a variety of panel data models, including stationary and unit root dynamic heterogeneous panels with short T and large N. The proposed tests are based on average of pair-wise correlation coefficients of the OLS residuals from the individual regressions in the panel, and can be used to test for cross section dependence of any fixed order p, as well as the case where no a priori ordering of the cross section units is assumed, referred to as CD(p) and CD tests, respectively. Asymptotic distributions of these tests are derived and their power function analyzed under different alternatives. It is shown that these tests are correctly centred for fixed N and T, and are robust to single or multiple breaks in the slope coefficients and/or error variances. The small sample properties of the tests are investigated and compared to the Lagrange multiplier test of Breusch and Pagan using Monte Carlo experiments. It is shown that the tests have the correct size in very small samples and satisfactory power, and as predicted by the theory, quite robust to the presence of unit roots and structural breaks. The use of the CD test is illustrated by applying it to study the degree of dependence in per capita output innovations across countries within a given region and across countries in different regions. The results show significant evidence of cross dependence in output innovations across many countries and regions in the world.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 1240.

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Length: 42 pages
Date of creation: Aug 2004
Date of revision:
Handle: RePEc:iza:izadps:dp1240

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Related research

Keywords: cross section dependence; spatial dependence; diagnostic tests; dynamic heterogenous panels; empirical growth;

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  1. M. Hashem Pesaran, 2003. "Estimation and Inference in Large Heterogenous Panels with Cross Section Dependence," CESifo Working Paper Series 869, CESifo Group Munich.
  2. N/A, 1973. "A Correction," The Indian Economic & Social History Review, , , vol. 10(2), pages 207-207, April.
  3. Pesaran, M. Hashem & Timmermann, Allan, 2005. "Small sample properties of forecasts from autoregressive models under structural breaks," Journal of Econometrics, Elsevier, Elsevier, vol. 129(1-2), pages 183-217.
  4. Ahn, Seung Chan & Hoon Lee, Young & Schmidt, Peter, 2001. "GMM estimation of linear panel data models with time-varying individual effects," Journal of Econometrics, Elsevier, Elsevier, vol. 101(2), pages 219-255, April.
  5. Baltagi, Badi H. & Song, Seuck Heun & Koh, Won, 2003. "Testing panel data regression models with spatial error correlation," Journal of Econometrics, Elsevier, Elsevier, vol. 117(1), pages 123-150, November.
  6. Robert J. Barro, 1996. "Determinants of Economic Growth: A Cross-Country Empirical Study," NBER Working Papers 5698, National Bureau of Economic Research, Inc.
  7. Lee, Kevin & Pesaran, M Hashem & Smith, Ron, 1997. "Growth and Convergence in Multi-country Empirical Stochastic Solow Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 12(4), pages 357-92, July-Aug..
  8. M. Hashem Pesaran & Til Schuermann & Scott M. Weiner, 2001. "Modelling regional interdependencies using a global error-correcting macroeconometric model," 10th International Conference on Panel Data, Berlin, July 5-6, 2002, International Conferences on Panel Data B4-1, International Conferences on Panel Data.
  9. Breusch, T S & Pagan, A R, 1980. "The Lagrange Multiplier Test and Its Applications to Model Specification in Econometrics," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 47(1), pages 239-53, January.
  10. Kevin Lee & M. Hashem Pesaran & Ron Smith, . "Growth and Convergence in a Multi-County empirical Stochastic Solow Model," Discussion Papers in Economics, Department of Economics, University of Leicester 96/14, Department of Economics, University of Leicester.
  11. Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, Econometric Society, vol. 49(6), pages 1417-26, November.
  12. Swamy, P A V B, 1970. "Efficient Inference in a Random Coefficient Regression Model," Econometrica, Econometric Society, Econometric Society, vol. 38(2), pages 311-23, March.
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