1---
 2meta: 
 3  date: false
 4  reading_time: false
 5title: "Specification Error"
 6date: 2023-10-05
 7description: "An error in estimation or inference caused by a false assumption in an econometric model."
 8tags: ["econometrics", "modeling", "bias"]
 9---
10
11## Background
12
13Specification error refers to an error arising within an econometric model due to incorrect assumptions about the underlying data-generating process. Such assumptions might relate to the inclusion or exclusion of certain variables, the functional form of the model, or the presence of erroneous data application.
14
15## Historical Context
16
17The conceptualization of specification errors became significant as econometrics progressed. With advancements in statistical methodologies and computational techniques, researchers became acutely aware of the impact of false model specifications on econometric analysis and inference.
18
19## Definitions and Concepts
20
21Specification error is a broad concept that encompasses multiple facets of errors in econometric modeling. This error can lead to biased estimators - where the expected value of the parameter estimates does not equal the true population values. Additionally, it can result in inefficiencies and inconsistencies, obstructing the reliability of the econometric analysis.
22
23Omitted variable bias and incorrect functional forms are common forms of specification error. Omitted variable bias occurs when critical explanatory variables are left out of a model, potentially leading to spurious inferences. Incorrect functional form arises when the assumed relationship between dependent and independent variables does not correctly represent the true data-generating process.
24
25## Major Analytical Frameworks
26
27### Classical Economics
28Unspecific within this framework, but classical delays emphasize market mechanisms which, if modeled incorrectly, may lead to specification error impacting policy recommendations.
29
30### Neoclassical Economics
31Within neoclassical economics, incorrect specifiers of utility functions, production functions, or cost functions can yield biased estimators of parameters crucial for theoretical and applied economics studies.
32
33### Keynesian Economic
34In Keynesian models, incorrect specifications can disrupt understanding the relationships between aggregate demand and supply, leading to erroneous interpretations of macroeconomic inferences.
35
36### Marxian Economics
37Incorrect structural assumptions in Marxian models analyzing class relations and labor dynamics can lead to misinterpretation in economic exploitation metrics and surplus value analysis.
38
39### Institutional Economics
40Specification errors in institutional frameworks could emerge through poorly schematized institutional interactions and influences, leading to biased historical or empirical conclusions.
41
42### Behavioral Economics
43Behavioral models rely heavily on assumed functional forms and psychological drivers. Incorrect specifications here could misrepresent how psychological factors impact economic decision-making.
44
45### Post-Keynesian Economics
46Post-Keyesian models focus on real-world data. Specification error involving functional forms and variable sets can undermine critical analyses of empirical phenomena, like unemployment or inflation.
47
48### Austrian Economics
49Austrians focus on methodological individualism; hence the errors in rationality or time preferences specifications can distort important inferences regarding market processes.
50
51### Development Economics
52Specification errors in development economic models may cloud understanding of growth processes, policy interventions, and poverty alleviation mechanisms.
53
54### Monetarism
55In monetarist models, the correct formulation of relations between money supply and economic variables is crucial. Errors occur when these relationships are mis-charted, leading to wrong policy prescripts.
56
57## Comparative Analysis
58
59Specification error manifests uniquely depending on the economic thought system, impacting how policy recommendations and empirical conclusions are assessed across frameworks. Comparative analysis helps isolate how particular economic theories afford more robust measures to diagnose and ameliorate specification mistakes.
60
61## Case Studies
62
631. Studying omitted variable bias: The impact of education on earnings, without controlling for inherent ability or family background, leads to biased estimates.
642. Incorrect functional form: Utilizing a linear model for diminishing returns production functions potentially leads to misunderstanding resource allocation impact.
65
66## Suggested Books for Further Studies
67
68- "Introductory Econometrics: A Modern Approach" by Jeffrey M. Wooldridge
69- "Econometric Analysis" by William H. Greene
70- "Specification Tests in Econometrics" by Lorraine Ivanciu Honoré
71
72## Related Terms with Definitions
73
74- **Omitted Variable Bias**: Bias resulting from leaving out significant variables from a model, causing erroneous internal inferences.
75- **Ramsey Regression Equation Specification Error Test**: A statistical test used to identify specification errors in regression models based on auxiliary regressors.