A simple and trustworthy asymptotic t test in difference-in-differences regressions

We propose an asymptotically valid t test that uses Student's t distribution as the reference distribution in a difference-in-differences regression. For the asymptotic variance estimation, we adopt the clustering-by-time approach to accommodate cross-sectional dependence. This approach often assumes the clusters to be independent across time, but we allow them to be temporally dependent. The proposed t test is based on a special heteroscedasticity and autocorrelation robust (HAR) variance estimator. We target the type I and type II errors and develop a testing-oriented method to select the underlying smoothing parameter. By capturing the estimation uncertainty of the HAR variance estimator, the t test has more accurate size than the corresponding normal test and is just as powerful as the latter. Compared to the nonstandard test developed in the literature, the standard t test is just as accurate but much more convenient to use. Model-based and empirical-data-based Monte Carlo simulations show that the t test works quite well in finite samples. (C) 2019 Elsevier B.V. All rights reserved.