Testing

Hypothesis testing is the customary instrument for analysing the empirical validity of an economic theory. This theory is reduced to a hypothesis which is tested in a statistical model. Hypothesis testing is thus an important tool for conducting statistical inference in economic models. An impressive literature has emerged which discusses tests of economic hypotheses. Instead of providing an incomplete overview of this literature, we provide a somewhat hands on discussion of testing in which we show how an economic theory is tested in a statistical model. We therefore begin with the discussion of the basic results on hypothesis testing and later focus on some recent developments that have improved testing in commonly used economic models. We use a real economic example to illustrate the main findings.