Statistical Inference on Partially Linear Panel Model under Unobserved Linearity

Abstract: A new statistical procedure, based on a modified spline basis, is proposed to identify the linear components in the panel data model with fixed effects. Under some mild assumptions, the proposed procedure is shown to consistently estimate the underlying regression function, correctly select the linear components, and effectively conduct the statistical inference. When compared to existing methods for detection of linearity in the panel model, our approach is demonstrated to be theoretically justified as well as practically convenient. We provide a computational algorithm that implements the proposed procedure along with a path-based solution method for linearity detection, which avoids the burden of selecting the tuning parameter for the penalty term. Monte Carlo simulations are conducted to examine the finite sample performance of our proposed procedure with detailed findings that confirm our theoretical results in the paper. Applications to Aggregate Production and Environmental Kuznets Curve data also illustrate the necessity for detecting linearity in the partially linear panel model.