Scandinavian Working Papers in Economics

Working Papers,
Hanken School of Economics

No 555: Practical Proposals for Specifying k-Nearest Neighbours Weights Matrices

Linda Gerkman () and Niklas Ahlgren ()
Additional contact information
Linda Gerkman: Department of Finance and Statistics, Postal: Hanken School of Economics, Arkadiankatu 22, P.O.B. 479; FIN 00101 Helsinki, Finland
Niklas Ahlgren: Department of Finance and Statistics, Postal: Hanken School of Economics, Arkadiankatu 22, P.O.B. 479; FIN 00101 Helsinki, Finland

Abstract: In this article we introduce and evaluate testing procedures for specifying the number k of nearest neighbours in the weights matrix of spatial econometric models. The spatial J-test is used for specification search. Two testing procedures are suggested: an increasing neighbours testing procedure and a decreasing neighbours testing procedure. Simulations show that the increasing neighbours testing procedures can be used in large samples to determine k. The decreasing neighbours testing procedure is found to have low power, and is not recommended for use in practice. An empirical example involving house price data is provided to show how to use the testing procedures with real data.

Keywords: k-nearest neighbours; model specification; spatial j-test; weights matrix

26 pages, May 18, 2011

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