Specification Tests for Time-Varying Coefficient Panel Data Models

Abstract

This paper provides nonparametric specification tests for the commonly used homogeneous and stable coefficients structures in panel data models. We first obtain the augmented residuals by estimating the model under the null hypothesis and then run auxiliary time series regressions of augmented residuals on covariates with time-varying coefficients (TVCs) via sieve methods. The test statistic is then constructed by averaging the squared fitted values, which are close to zero under the null and deviate from zero under the alternatives. We show that the test statistic, after being appropriately standardized, is asymptotically normal under the null and under a sequence of Pitman local alternatives. A bootstrap procedure is proposed to improve the finite sample performance of our test. In addition, we extend the procedure to test other structures, such as the homogeneity of TVCs or the stability of heterogeneous coefficients. The joint test is extended to panel models with two-way fixed effects. Monte Carlo simulations indicate that our tests perform reasonably well in finite samples. We apply the tests to re-examine the environmental Kuznets curve in the United States, and find that the model with homogenous TVCs is more appropriate for this application.