Semi-nonparametric estimation and misspecification testing of diffusion models

Novel transition-based misspecification tests of semiparametric and fully parametric univariate diffusion models based on the estimators developed in Kristensen, D., 2010. Pseudo-maximum likelihood estimation in two classes of semiparametric diffusion models. Journal of Econometrics 156, 239-259] are proposed. It is demonstrated that transition-based tests in general lack power in detecting certain departures from the null since they integrate out local features of the drift and volatility. As a solution to this, tests that directly compare drift and volatility estimators under the relevant null and alternative are also developed which exhibit better power against local alternatives.