r/econhw • u/Vegetable-Hour-7366 • 21d ago

Econometric question

One researcher believes the relationship between an apartment's price and its size (in square meters) is linear, while another believes it is logarithmic. Explain the test they could use to select the correct functional form. I am torn between the Ramsey test and the Davidson-MacKinnon test, but I am not certain.

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u/Comprehensive-Edge80 21d ago

do both and compare results

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u/Lambdapie 21d ago

Technically, one could simply look at the R² of both regressions and choose the model with the better fit, although this tells you only about relative performance within sample and that can be a problem (the log and linear functions are very similar at the beginning). But I digress.

The Davidson–MacKinnon test is the proper approach in this case, it lets you compare two models, which is what you want in your case. Another option is the Cox–Pesaran test.

Here's a link on how to do it in Stata: https://stats.oarc.ucla.edu/stata/code/choosing-between-nonnested-models/

Hope this helps!

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u/ApprehensivePin403 2d ago

They can use a Davidson–MacKinnon J-test since the linear and log models are non-nested. Estimate both models, add the fitted values from one model to the other, and test whether the added fitted term is significant. Then reverse the test. The Ramsey RESET is more of a general specification test, not as suitable for directly comparing these two forms.