Omitted Variables Bias in Regime-Switching Models with Slope-Constrained Estimators: Evidence from Monte Carlo Simulations

Ermanno Affuso, Steven B Caudill, Franklin Mixon and Jr.

Journal of Statistical and Econometric Methods, 2013, vol. 2, issue 3, 5

Abstract: In a recent study, Beccarini [1] showed that one can eliminate or reduce the bias in OLS regression estimators caused by an omitted polychotomous variable by estimating a regime-switching model. If the missing polychotomous variable assumes K values, then elimination or reduction of the bias requires the estimation of a K-component mixture model. In his Monte Carlo simulations, however, the slope of the parameter of interest is estimated once for each of the K components. After discussing problems associated with multiple estimates of the parameter of interest, this paper extends Beccarini’s Monte Carlo analysis to include the slope-constrained estimator obtained by using the EM algorithm of Bartolucci and Scaccia [2]. We find a small gain in efficiency with the slope-constrained estimator and that the weighted-average estimator in Beccarini [1] produces a large number of rejections of the true null hypothesis of a single slope when the components are not widely separated.

Date: 2013
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