The Incidental Parameters Problem in Testing for Remaining Cross-Section Correlation

In this article, we consider the properties of the Pesaran CD test for cross-section correlation when applied to residuals obtained from panel data models with many estimated parameters. We show that the presence of period-specific parameters leads the CD test statistic to diverge as the time dimension of the sample grows. This result holds even if cross-section dependence is correctly accounted for and hence constitutes an example of the...