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Test for the Error Component Model in the Presence of Local Misspecification

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  • Anil Bera
  • Walter Sosa Escudero
  • Mann Yoon

Abstract

It is well known that most of the standard speci¯cation tests are not valid when the alternative hypothesis is misspeci¯ed. This is particularly true in the error component model, when one tests for either random e®ects or serial correlation without taking account of the presence of the other e®ect. In this paper we study the size and power of the standard Rao's score tests analytically and by simulation when the data is contaminated by local misspeci¯cation. These tests are adversely a®ected under misspeci¯cation. We suggest simple procedures to test for random e®ects (or serial correlation) in the presence of local serial correlation (or random e®ects), and these tests require ordinary least squares residuals only. Our Monte Carlo results demonstrate that the suggested tests have good ¯nite sample properties for local misspeci¯cation, and in some cases even for far distant misspeci¯cation. Our tests are also capable of detecting the right direction of the departure from the null hypothesis. We also provide some empirical illustrations to highlight the usefulness of our tests.

Suggested Citation

  • Anil Bera & Walter Sosa Escudero & Mann Yoon, 2000. "Test for the Error Component Model in the Presence of Local Misspecification," Department of Economics, Working Papers 022, Departamento de Economía, Facultad de Ciencias Económicas, Universidad Nacional de La Plata.
  • Handle: RePEc:lap:wpaper:022
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    References listed on IDEAS

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    6. Baltagi, Badi H. & Chang, Young-Jae & Li, Qi, 1992. "Monte Carlo results on several new and existing tests for the error component model," Journal of Econometrics, Elsevier, vol. 54(1-3), pages 95-120.
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    8. Bera, Anil K. & Yoon, Mann J., 1993. "Specification Testing with Locally Misspecified Alternatives," Econometric Theory, Cambridge University Press, vol. 9(04), pages 649-658, August.
    9. Baltagi, Badi H. & Li, Qi, 1991. "A joint test for serial correlation and random individual effects," Statistics & Probability Letters, Elsevier, vol. 11(3), pages 277-280, March.
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    11. Hillier, Grant H., 1991. "On multiple diagnostic procedures for the linear model," Journal of Econometrics, Elsevier, vol. 47(1), pages 47-66, January.
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