Estimation of a Stratified Error‐Components Model*

This article shows that the presence of incidental parameters in Baltagi and Griffin's (International Economic Review 29 (1988), 745–53) generalized error‐components model implies there is no guarantee feasible and true GLS estimators have the same asymptotic distribution. The article then considers a related stratified error‐components model that has no incidental parameters. In this model, unobserved heterogeneity occurs through variances changing across strata. The article provides an EM algorithm for calculating estimates of the model's parameters without assuming observations can be classified into strata, derives a bootstrap test for identifying the number of strata, and applies the new methods in an example.     

How Does Industry Affect Firm Financial Structure?

We examine the importance of industry to firm-level financialand real decisions. We find that in addition to standard industryfixed effects, financial structure also depends on a firm’sposition within its industry. In competitive industries, a firm’sfinancial leverage depends on its natural hedge (its proximityto the median industry capital–labor ratio), the actionsof other firms in the industry, and its status as entrant, incumbent,or exiting firm. Financial leverage is higher and less dispersedin concentrated industries, where strategic debt interactionsare also stronger, but a firm’s natural hedge is not significant.Our results show that financial structure, technology, and riskare jointly determined within industries. These findings areconsistent with recent industry equilibrium models of financialstructure.     

Pythagorean generalization of testing the equality of two symmetric positive definite matrices

We provide a new test for equality of two symmetric positive-definite matrices that leads to a convenient mechanism for testing specification using the information matrix equality or the sandwich asymptotic covariance matrix of the GMM estimator. The test relies on a new characterization of equality between two $k$ dimensional symmetric positive-definite matrices $A$ and $B$: the traces of $A{B}^{?1}$ and $B{A}^{?1}$ are equal to $k$ if and only if $A=B$. Using this simple criterion, we introduce a class of omnibus test statistics for equality and examine their null and local alternative approximations under some mild regularity conditions. A preferred test in the class with good omni-directional power is recommended for practical work. Monte Carlo experiments are conducted to explore performance characteristics under the null and local as well as fixed alternatives. The test is applicable in many settings, including GMM estimation, SVAR models and high dimensional variance matrix settings.     

Robust tests of forward exchange market efficiency with empirical evidence from the 1920s

This paper provides a robust statistical approach to testing the unbiasedness hypothesis in forward exchange market efficiency studies. The methods we use allow us to work explicitly with levels rather than differenced data. They are statistically robust to data distributions with heavy tails, and they can be applied to data sets where the frequency of observation and the futures maturity do not coincide. In addition, our methods allow for stochastic trend non-stationarity and general forms of serial dependence. The methods are applied to daily data of spot exchange rates and forward exchange rates during the 1920s, which marked the first episode of a broadly general floating exchange rate system. The tail behaviour of the data is analysed using an adaptive data-based method for estimating the tail slope of the density. The results confirm the need for the use of robust regression methods. We find cointegration between the forward rate and spot rate for the four currencies we consider (the Belgian and French francs, the Italian lira and the US dollar, all measured against the British pound), we find support for a stationary risk premium in the case of the Belgian franc, the Italian lira and the US dollar, and we find support for the simple market efficiency hypothesis (where the forward rate is an unbiased predictor of the future spot rate and there is a zero mean risk premium) in the case of the US dollar.     

Communicating the health effects of consumer products: The case of moderate alcohol consumption and coronary heart disease

Moderate consumption of alcoholic beverages (MAC) has been estimated to significantly reduce the risk of myocardial infarction. This paper examines effective ways to communicate this information to guide individuals and their physicians, who must weight personal benefits and costs when deciding about drinking. It argues that presenting a scalar representation of the effect, life years saved, is much more effective than the ways such information is currently communicated. A simulation using data from the Framingham Heart Study and a conservative estimate of the effect of MAC calculates age-specific gains in mortality, and survival gains from MAC. They are roughly 0.75 and 0.63 years, respectively, for men and women ages 21–50. Any MAC decision should weigh the benefits of cardiac risk reduction against possible financial, lifestyle or offsetting health costs.     

A sequential approach to testing for structural change in econometric models

The paper shows that the sequential approach to testing econometric models, particularly testing for structural change, is both feasible and potentially very useful. In fact, this paper makes clear the possibility of using the sequential approach as suggested by Dhrymes et al. (1972) and shows that the statistical dependence between successive tests can be overcome in some cases.Helpful comments by David Hendry, Grayham Mizon and Jan Kiviet, on an earlier version of a related Paper, are gratefully acknowledged.