Panel Unit Root Tests in the Presence of a Multifactor Error Structure

Mohammad Pesaran, L. Vanessa Smith and Takashi Yamagata

No 3254, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: This paper extends the cross sectionally augmented panel unit root test proposed by Pesaran (2007) to the case of a multifactor error structure. The basic idea is to exploit information regarding the unobserved factors that are shared by other time series in addition to the variable under consideration. Importantly, our test procedure only requires specification of the maximum number of factors, in contrast to other panel unit root tests based on principal components that require in addition the estimation of the number of factors as well as the factors themselves. Small sample properties of the proposed test are investigated by Monte Carlo experiments, which suggest that it controls well for size in almost all cases, especially in the presence of serial correlation in the error term, contrary to alternative test statistics. Empirical applications to Fisher's inflation parity and real equity prices across different markets illustrate how the proposed test works in practice.

Keywords: real equity prices; multi-factor residual structure; cross section dependence; panel unit root tests; Fisher inflation parity (search for similar items in EconPapers)
JEL-codes: C12 C15 C22 C23 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2007-12
New Economics Papers: this item is included in nep-ecm and nep-ets
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Citations: View citations in EconPapers (884)

Published - revised version published in: Journal of Econometrics, 2013, 175(2), 94-115

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https://docs.iza.org/dp3254.pdf (application/pdf)

Related works:
Journal Article: Panel unit root tests in the presence of a multifactor error structure (2013)
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)
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