Partially linear functional-coefficient dynamic panel data models: sieve estimation and specification testing

Abstract We study the nonparametric estimation and specification testing for partially linear functional-coefficient dynamic panel data models, where the effects of some covariates on the dependent variable vary nonparametrically according to a set of low-dimensional variables. Based on the sieve approximation of unknown slope functions, we propose a sieve 2SLS procedure to estimate the model. The asymptotic properties of the estimators of both parametric and nonparametric components are established when sample size N and T tend to infinity jointly. A nonparametric specification test for the constancy of slopes is also proposed. We show that after being appropriately standardized, the test is asymptotically normally distributed under the null hypothesis. The asymptotic properties of the test is also studied under a sequence of local Pitman alternatives and global alternatives. A set of Monte Carlo simulations show that our sieve 2SLS estimators and specification test perform remarkably well in finite samples. We apply our method to study the impact of income on democracy, and find strong evidence of nonlinear/nonconstant effect of income on democracy.