Diagnostic Testing in Applied Econometrics*

Abstract

Economic policy formation and the development of economic theory both rely ultimately upon empirical analysis for their direction and sustenance. Recent contributions from econometric theory suggest that the quality of the advice obtained from applied econometric research can be considerably improved by more systematic testing of empirical models. These new tests help identify both strengths and weaknesses of the models. Though fundamental economic theory and good knowledge of data are the primary ingredients of applied economic research, these new diagnostic tests are an important adjunct to existing methodology. This survey introduces the non‐specialist econometrician to diagnostic model testing, and thoughout emphasizes the heuristic rather than the mathematical underpinnings of the testing strategy.