Exact tests for contemporaneous correlation of disturbances in seemingly unrelated regressions

This paper proposes finite-sample procedures for testing the SURE specification in multi-equation regression models, i.e. whether the disturbances in different equations are contemporaneously uncorrelated or not. We apply the technique of Monte Carlo (MC) tests, see Dwass and Barnard, respectively (Ann. Math. Statist. 28 (1957) 181; J.R. Statist. Soc. Ser. B 25 (1963) 294) to obtain exact tests based on standard LR and LM zero correlation tests. We also suggest a MC quasi-LR (QLR) test based on feasible generalized least squares (FGLS). We show that the latter statistics are pivotal under the null, which provides the justification for applying MC tests. Furthermore, we extend the exact independence test proposed by Harvey and Phillips (Bull. Econ. Res. 34 (2) (1982) 79) to the multi-equation framework. Specifically, we introduce several induced tests based on a set of simultaneous Harvey/Phillips-type tests and suggest a simulation-based solution to the associated combination problem. The properties of the proposed tests are studied in a Monte Carlo experiment which shows that standard asymptotic tests exhibit important size distortions, while MC tests achieve complete size control and display good power. Moreover, MC-QLR tests performed best in terms of power, a result of interest from the point of view of simulation-based tests. The power of the MC induced tests improves appreciably in comparison to standard Bonferroni tests and in certain cases outperform the likelihood-based MC tests. The tests are applied to data used by Fischer (J. Monetary Econ. 32, 485) (1993) to analyze the macroeconomic determinants of growth.