Testing for a Unit Root in Panels with Dynamic Factors

Hyungsik Roger Moon () and Benoit Perron ()

Cahiers de recherche from Centre interuniversitaire de recherche en économie quantitative, CIREQ

Abstract: This paper studies testing for a unit root for large n and T panels in which the cross-sectional units are correlated. To model this cross-sectional correlation, we assume that the data is generated by an unknown number of unobservable common factors. We propose unit root tests in this environment and derive their (Gaussian) asymptotic distribution under the null hypothesis of a unit root and local alternatives. We show that these tests have significant asymptotic power when the model has no incidental trends. However, when there are incidental trends in the model and it is necessary to remove heterogeneous deterministic components, we show that these tests have no power against the same local alternatives. Through Monte Carlo simulations, we provide evidence on the finite sample properties of these new tests.

Keywords: Unit roots; panel data; factor models (search for similar items in EconPapers)
Date: Written 2002
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Related works:
Working Paper: Testing for a Unit Root in Panels with Dynamic Factors (2002)
Journal Article: Testing for a unit root in panels with dynamic factors (2004)
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