Testing for sphericity in a fixed effects panel data model

Abstract

Summary This paper proposes a test for the null of sphericity in a fixed effects panel data model. It uses the Random Matrix Theory based approach of Ledoit and Wolf to test for the null of sphericity of the error terms in a fixed effects panel model with a large number of cross-sectional units and time series observations. Because the errors are unobservable, the residuals from the fixed effects regression are used. The limiting distribution of the proposed test statistic is derived. In addition, its finite sample properties are examined using Monte Carlo simulations.