Unit Root Testing in Heteroscedastic Panels Using the Cauchy Estimator

Matei Demetrescu and Christoph Hanck

Journal of Business & Economic Statistics, 2011, vol. 30, issue 2, 256-264

Abstract: The Cauchy estimator of an autoregressive root uses the sign of the first lag as instrumental variable. The resulting IV t -type statistic follows a standard normal limiting distribution under a unit root case even under unconditional heteroscedasticity, if the series to be tested has no deterministic trends. The standard normality of the Cauchy test is exploited to obtain a standard normal panel unit root test under cross-sectional dependence and time-varying volatility with an orthogonalization procedure. The article’s analysis of the joint N , T asymptotics of the test suggests that (1) N should be smaller than T and (2) its local power is competitive with other popular tests. To render the test applicable when N is comparable with, or larger than, T , shrinkage estimators of the involved covariance matrix are used. The finite-sample performance of the discussed procedures is found to be satisfactory.

Date: 2011
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DOI: 10.1080/07350015.2011.638839

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