A Bias-Adjusted LM Test of Error Cross Section Independence
This paper proposes bias-adjusted normal approximation versions of Lagrange multiplier (NLM) test of error cross section independence of Breusch and Pagan (1980) in the case of panel models with strictly exogenous regressors and normal errors. The exact mean and variance of the Lagrange multiplier (LM) test statistic are provided for the purpose of the bias-adjustments, and it is shown that the proposed tests have a standard normal distribution for the fixed time series dimension (T) as the cross section dimension (N) tends to infinity. Importantly, the proposed bias-adjusted NLM tests are consistent even when the Pesaran’s (2004) CD test is inconsistent. The finite sample evidence shows that the bias adjusted NLM tests successfully control the size, maintaining satisfactory power. However, it is also shown that the bias-adjusted NLM tests are not as robust as the CD test to non-normal errors and/or in the presence of weakly exogenous regressors.
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- Ullah, Aman, 2004. "Finite Sample Econometrics," OUP Catalogue, Oxford University Press, number 9780198774488.
- T. S. Breusch & A. R. Pagan, 1980.
"The Lagrange Multiplier Test and its Applications to Model Specification in Econometrics,"
Review of Economic Studies,
Oxford University Press, vol. 47(1), pages 239-253.
- Breusch, T.S. & Pagan, A.R., "undated". "The Lagrange multiplier test and its applications to model specification in econometrics," CORE Discussion Papers RP 412, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Pesaran, M.H., 2004. "‘General Diagnostic Tests for Cross Section Dependence in Panels’," Cambridge Working Papers in Economics 0435, Faculty of Economics, University of Cambridge.
- Pesaran, M. Hashem, 2004. "General Diagnostic Tests for Cross Section Dependence in Panels," IZA Discussion Papers 1240, Institute for the Study of Labor (IZA).
- M. Hashem Pesaran, 2004. "General Diagnostic Tests for Cross Section Dependence in Panels," CESifo Working Paper Series 1229, CESifo Group Munich.
- Frees, Edward W., 1995. "Assessing cross-sectional correlation in panel data," Journal of Econometrics, Elsevier, vol. 69(2), pages 393-414, October. Full references (including those not matched with items on IDEAS)
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