Wednesday, April 3, 2019

What is a Permutation Test?

Permutation tests, which I'll be discussing in this post, aren't that widely used by econometricians. However, they shouldn't be overlooked.

Let's begin with some background discussion to set the scene. This might seem a bit redundant, but it will help us to see how permutation tests differ from the sort of tests that we usually use in econometrics.

Background Motivation

When you took your first course in economic statistics, or econometrics, no doubt you encountered some of the basic concepts associated with testing hypotheses. I'm sure that the first exposure that you had to this was actually in terms of "classical", Neyman-Pearson, testing. 

It probably wasn't described to you in so many words. It would have just been "statistical hypothesis testing". The whole procedure would have been presented, more or less, along the following lines: