The Hausman test in a Cliff and Ord panel model

Summary This paper studies the random effects model and the fixed effects model for spatial panel data. The model includes a Cliff and Ord type spatial lag of the dependent variable as well as a spatially lagged one‐way error component structure, accounting for both heterogeneity and spatial correlation across units. We discuss instrumental variable estimation under both the fixed and the random effects specifications and propose a spatial Hausman test which compares these two models accounting for spatial autocorrelation in the disturbances. We derive the large sample properties of our estimation procedures and show that the test statistic is asymptotically chi‐square distributed. A small Monte Carlo study demonstrates that this test works well even in small panels.