Transformation of Variables in Econometrics
Economic theory usually fails to describe the functional relationship between variables (the CES production function being an exception). In econometrics, implications of simplistic choice of functional form include the danger of misspecification and its attendant biases in assessing magnitudes of effects and statistical significance of results. It is safe to say that when functional form is specified in a restrictive manner a priori before estimation, most empirical results that have been debated in the professional literature would have had a modified, even opposite, conclusion if the functional relationship had not been restrictive (see Zarembka 1968, p. 509, for an illustration; also, Spitzer 1976).
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