The Incidental Parameters Problem in Testing for Remaining Cross-Section Correlation
(2022) In Journal of Business and Economic Statistics 40(3). p.1191-1203- Abstract
In this article, we consider the properties of the Pesaran CD test for cross-section correlation when applied to residuals obtained from panel data models with many estimated parameters. We show that the presence of period-specific parameters leads the CD test statistic to diverge as the time dimension of the sample grows. This result holds even if cross-section dependence is correctly accounted for and hence constitutes an example of the incidental parameters problem. The relevance of this problem is investigated for both the classical two-way fixed-effects estimator and the Common Correlated Effects estimator of Pesaran. We suggest a weighted CD test statistic which re-establishes standard normal inference under the null hypothesis.... (More)
In this article, we consider the properties of the Pesaran CD test for cross-section correlation when applied to residuals obtained from panel data models with many estimated parameters. We show that the presence of period-specific parameters leads the CD test statistic to diverge as the time dimension of the sample grows. This result holds even if cross-section dependence is correctly accounted for and hence constitutes an example of the incidental parameters problem. The relevance of this problem is investigated for both the classical two-way fixed-effects estimator and the Common Correlated Effects estimator of Pesaran. We suggest a weighted CD test statistic which re-establishes standard normal inference under the null hypothesis. Given the widespread use of the CD test statistic to test for remaining cross-section correlation, our results have far reaching implications for empirical researchers.
(Less)
- author
- Juodis, Artūras and Reese, Simon LU
- organization
- publishing date
- 2022
- type
- Contribution to journal
- publication status
- published
- subject
- keywords
- Cross-section dependence, Factor model, Panel data, Time fixed effects, U-statistic
- in
- Journal of Business and Economic Statistics
- volume
- 40
- issue
- 3
- pages
- 1191 - 1203
- publisher
- American Statistical Association
- external identifiers
-
- scopus:85105355423
- ISSN
- 0735-0015
- DOI
- 10.1080/07350015.2021.1906687
- language
- English
- LU publication?
- yes
- id
- 0714d3e8-a9d4-4049-a942-e6af9bd0510e
- date added to LUP
- 2021-05-31 14:59:02
- date last changed
- 2022-06-30 16:04:41
@article{0714d3e8-a9d4-4049-a942-e6af9bd0510e,
abstract = {{<p>In this article, we consider the properties of the Pesaran CD test for cross-section correlation when applied to residuals obtained from panel data models with many estimated parameters. We show that the presence of period-specific parameters leads the CD test statistic to diverge as the time dimension of the sample grows. This result holds even if cross-section dependence is correctly accounted for and hence constitutes an example of the incidental parameters problem. The relevance of this problem is investigated for both the classical two-way fixed-effects estimator and the Common Correlated Effects estimator of Pesaran. We suggest a weighted CD test statistic which re-establishes standard normal inference under the null hypothesis. Given the widespread use of the CD test statistic to test for remaining cross-section correlation, our results have far reaching implications for empirical researchers.</p>}},
author = {{Juodis, Artūras and Reese, Simon}},
issn = {{0735-0015}},
keywords = {{Cross-section dependence; Factor model; Panel data; Time fixed effects; U-statistic}},
language = {{eng}},
number = {{3}},
pages = {{1191--1203}},
publisher = {{American Statistical Association}},
series = {{Journal of Business and Economic Statistics}},
title = {{The Incidental Parameters Problem in Testing for Remaining Cross-Section Correlation}},
url = {{http://dx.doi.org/10.1080/07350015.2021.1906687}},
doi = {{10.1080/07350015.2021.1906687}},
volume = {{40}},
year = {{2022}},
}