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Diagnostic Tests of Cross‐Section Independence for Limited Dependent Variable Panel Data Models*

25 Pages Posted: 10 Feb 2012  

Cheng Hsiao

University of Southern California - Department of Economics; National Taiwan University; National Bureau of Economic Research (NBER)

M. Hashem Pesaran

USC Dornsife Institute for New Economic Thinking; University of Southern California; Trinity College, Cambridge

Andreas Pick

Erasmus University Rotterdam (EUR) - Department of Econometrics; De Nederlandsche Bank

Date Written: April 2012

Abstract

This article considers the problem of testing for cross‐section independence in limited dependent variable panel data models. It derives a Lagrangian multiplier (LM) test and shows that in terms of generalized residuals of Gourieroux et al. (1987) it reduces to the LM test of Breusch and Pagan (1980). Because of the tendency of the LM test to over‐reject in panels with large N (cross‐section dimension), we also consider the application of the cross‐section dependence test (CD) proposed by Pesaran (2004). In Monte Carlo experiments it emerges that for most combinations of N and T the CD test is correctly sized, whereas the validity of the LM test requires T (time series dimension) to be quite large relative to N. We illustrate the cross‐sectional independence tests with an application to a probit panel data model of roll‐call votes in the US Congress and find that the votes display a significant degree of cross‐section dependence.

JEL Classification: C12, C33, C35

Suggested Citation

Hsiao, Cheng and Pesaran, M. Hashem and Pick, Andreas, Diagnostic Tests of Cross‐Section Independence for Limited Dependent Variable Panel Data Models* (April 2012). Oxford Bulletin of Economics and Statistics, Vol. 74, Issue 2, pp. 253-277, 2012. Available at SSRN: https://ssrn.com/abstract=2002489 or http://dx.doi.org/10.1111/j.1468-0084.2011.00646.x

Cheng Hsiao (Contact Author)

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States

National Taiwan University

1 Sec. 4, Roosevelt Road,
Taipei, 106
Taiwan

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

M. Hashem Pesaran

USC Dornsife Institute for New Economic Thinking ( email )

3620 S. Vermont Avenue, KAP 364F
Los Angeles, CA 90089-0253
United States

University of Southern California ( email )

Los Angeles, CA 90089
United States

Trinity College, Cambridge ( email )

United Kingdom

Andreas Pick

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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