The small sample properties of the reset test as applied to systems of equations

Abstract

The RESET test for functional misspecification is generalised to cover systems of equations, and the properties of 7 versions are studied using Monte Carlo methods. The Rao F -test clearly exhibits the best performance as regards correct size, whilst the commonly used LRT (uncorrected for degrees-of-freedom), and LM and Wald tests (both corrected and uncorrected) behave badly even in single equations. The Rao test exhibits correct size even in ten equation systems, which is better than previous research concerning autocorrelation tests. The power of the test is low, however, when the number of equations grows and the correlation between the omitted variables and the RESET proxies is small.