Testing for Sphericity in a Fixed E¤ects Panel Data Model

This paper proposes a test for the null of sphericity in a …xed e¤ects panel data model. It uses the Random Matrix Theory based approach of Ledoit and Wolf (2002) to test for the null of sphericity of the error terms in a …xed e¤ects panel model with a large number of cross-sectional units and time series observations. Since the errors are unobservable, the residuals from the …xed e¤ects regression are used. The limiting distribution of the proposed test statistic is derived. Additionally, its …nite sample properties are examined using Monte Carlo simulations. Keywords: Sphericity; Panel Data; Cross-sectional Dependence; John Test. JEL Classi…cation: C13; C33. Email Addresses: Badi H. Baltagi, [email protected]; Qu Feng, [email protected]; Chihwa Kao, [email protected]. We would like to thank the editor Jaap Abbring and two anonymous referees for their useful comments and suggestions.