Functional Coefficient Models for Economic and Financial Data

Abstract

This article discusses the use of functional coefficient models for economic and financial data analysis. It first provides an overview of recent developments in the nonparametric estimation and testing of functional coefficient models, with particular emphasis on the kernel local polynomial smoothing method, before considering misspecification testing as an important econometric question when fitting a functional (varying) coefficient model or a trending time-varying coefficient model. It then describes two major real-life applications of functional coefficient models in economics and finance: the first deals with the use of functional coefficient instrumental-variable models to investigate the empirical relation between wages and education in a random sample of young Australian female workers from the 1985 wave of the Australian Longitudinal Survey, and the second is concerned with the use of functional coefficient beta models to analyze the common stock price of Microsoft stock (MSFT) during the year 2000 using the daily closing prices.