System GMM estimation of panel data models with time varying slope coefficients

Abstract

We highlight the fact that the Sargan-Hansen test for GMM estimators applied to panel data is a joint test of valid orthogonality conditions and coefficient stability over time. A possible reason why the null hypothesis of valid orthogonality conditions is rejected is therefore that the slope coefficients vary over time. One solution is to estimate an empirical model where the coeefficients are time specifi c. We apply this solution to the system GMM estimatior of the Cobb-Douglas production functions for a selection of Swedish industries, and fi nd that relaxing the assumption that slope coefficients are constant over time results in considerably more satisfactory outcomes of the Sargan-Hansen test.