A robust specification test in linear panel data models

Abstract

The presence of outlying observations may adversely affect statistical testing procedures that result in unstable test statistics and unreliable inferences depending on the distortion in parameter estimates. In spite of the fact that the adverse effects of outliers in panel data models, there are only a few robust testing procedures available for model specification. In this paper, a new weighted likelihood based robust specification test is proposed to determine the appropriate approach in panel data including individual-specific components. The proposed test has been shown to have the same asymptotic distribution as that of most commonly used Hausman's specification test under null hypothesis of random effects specification. The finite sample properties of the robust testing procedure are illustrated by means of Monte Carlo simulations and an economic-growth data from the member countries of the Organisation for Economic Co-operation and Development. Our records reveal that the robust specification test exhibit improved performance in terms of size and power of the test in the presence of contamination.