Panel unit root tests in the presence of a multifactor error structure

Mohammad Pesaran, L. Vanessa Smith and Takashi Yamagata

Journal of Econometrics, 2013, vol. 175, issue 2, 94-115

Abstract: This paper extends the cross-sectionally augmented panel unit root test (CIPS) proposed by Pesaran (2007) to the case of a multifactor error structure, and proposes a new panel unit root test based on a simple average of cross-sectionally augmented Sargan–Bhargava statistics (CSB). The basic idea is to exploit information regarding the m unobserved factors that are shared by k observed time series in addition to the series under consideration. Initially, we develop the tests assuming that m0, the true number of factors, is known and show that the limit distribution of the tests does not depend on any nuisance parameters, so long as k≥m0−1. Small sample properties of the tests are investigated by Monte Carlo experiments and are shown to be satisfactory. Particularly, the proposed CIPS and CSB tests have the correct size for all combinations of the cross section (N) and time series (T) dimensions considered. The power of both tests rises with N and T, although the CSB test performs better than the CIPS test for smaller sample sizes. The various testing procedures are illustrated with empirical applications to real interest rates and real equity prices across countries.

Keywords: Panel unit root tests; Cross section dependence; Multifactor error structure; Fisher inflation parity; Real equity prices (search for similar items in EconPapers)
JEL-codes: C12 C15 C22 C23 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (129)

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Related works:
Working Paper: Panel Unit Root Tests in the Presence of a Multifactor Error Structure (2008)
Working Paper: Panel Unit Root Tests in the Presence of a Multifactor Error Structure (2008)
Working Paper: Panel Unit Root Tests in the Presence of a Multifactor Error Structure (2007)
Working Paper: Panel Unit Root Tests in the Presence of a Multifactor Error Structure (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:175:y:2013:i:2:p:94-115

DOI: 10.1016/j.jeconom.2013.02.001

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