Inference Problems Under a Special Form of Heteroskedasticity

21 Pages Posted: 12 Mar 2015

See all articles by Helmut Farbmacher

Helmut Farbmacher

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA)

Heinrich Kögel

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA)

Date Written: March 10, 2015

Abstract

In the presence of heteroskedasticity, conventional standard errors (which assume homoskedasticity) can be biased up or down. The most common form of heteroskedasticity leads to conventional standard errors that are too small. When Wald tests based on these standard errors are insignificant, heteroskedasticity robust standard errors do not change inference. On the other hand, inference is conservative in a setting with upward-biased conventional standard errors. We discuss the power gains when using robust standard errors in this case and also potential problems of heteroskedasticity tests. As a solution for the poor performance of the usual heteroskedasticity tests in this setting, we propose a modification of the White test which has better properties. We illustrate our findings using a study in labor economics. The correct standard errors turn out to be around 15 percent lower, leading to different policy conclusions. Moreover, only our modified test is able to detect heteroskedasticity in this application.

Suggested Citation

Farbmacher, Helmut and Kögel, Heinrich, Inference Problems Under a Special Form of Heteroskedasticity (March 10, 2015). Max Planck Institute for Social Law and Social Policy Discussion Paper No. 03-2015. Available at SSRN: https://ssrn.com/abstract=2576642 or http://dx.doi.org/10.2139/ssrn.2576642

Helmut Farbmacher (Contact Author)

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA) ( email )

Amalienstrasse 33
Munich, 80799
Germany

Heinrich Kögel

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA) ( email )

Amalienstrasse 33
Munich, 80799
Germany

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