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

University of Illinois, Bureau of Economics & Business Research Working Paper 98-0103

Posted: 25 Feb 1998

See all articles by Anil K. Bera

Anil K. Bera

University of Illinois at Urbana-Champaign - Department of Economics

Walter Sosa-Escudero

Universidad Nacional de La Plata - Faculty of Economics

Mann Yoon

California State University, Los Angeles - Department of Economics & Statistics

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Abstract

It is well known that most of the standard specification tests are not valid when the alternative hypothesis is misspecified. This is particularly true in the error component model when one tests for either random effects or serial correlation without taking account of the presence of the other effect. 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 misspecification. These tests are adversely affected under misspecification. We suggest simple procedures to test for random effects (or serial correlation) in the presence of local serial correlation (or random effects), and these tests require ordinary least squares residuals only. Our Monte Carlo results demonstrate that the suggested tests have good finite sample properties and are 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.

JEL Classification: C12, C51

Suggested Citation

Bera, Anil K. and Sosa-Escudero, Walter and Yoon, Mann, Tests for the Error Component Model in the Presence of Local Misspecification. University of Illinois, Bureau of Economics & Business Research Working Paper 98-0103, Available at SSRN: https://ssrn.com/abstract=62028

Anil K. Bera (Contact Author)

University of Illinois at Urbana-Champaign - Department of Economics ( email )

410 David Kinley Hall
1407 W. Gregory
Urbana, IL 61801
United States
217-333-4596 (Phone)
217-244-6678 (Fax)

Walter Sosa-Escudero

Universidad Nacional de La Plata - Faculty of Economics ( email )

1900 La Plata
Argentina
(541) 553-9983 (Phone)

Mann Yoon

California State University, Los Angeles - Department of Economics & Statistics ( email )

Los Angeles
Los Angeles, CA 90032
United States

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