Transforming the error-components model for estimation with general ARMA disturbances

Baltagi and Li (1991) give a transformation which may be applied to certain autocorrelated disturbances in an error-components model to yield spherical disturbances. They derive the transformation for AR(1) and AR(2) cases. We show that the results of Galbraith and Zinde-Walsh (1992) on the general ARMA form of the transformation matrix can be applied to allow estimation of the error-components model with disturbances which follow any ARMA (p, q) process. We also show that, for models with a cross-sectional dimension which is large relative to the time dimension, it is possible to use this method to perform a general autocorrelation transformation without specifying a particular ARMA process or estimating ARMA parameters.