Testing for a Unit Root in Panels with Dynamic Factors

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 asympotitic 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.

Institutional Quality, Trade Openness, and Financial Sector Development in Asia: An Empirical Investigation

“…The first group consists of firstgeneration unit root tests that ignore cross-sectional dependence. The second group includes secondgeneration unit root tests that take cross-sectional dependence into account (e.g., Phillips and Sul 2003, Moon and Perron 2004, Smith et al 2004, Pesaran 2007. Pesaran (2007) introduced a framework in which he allowed → for a positive real value.…”

Remittance and domestic labor productivity: Evidence from remittance recipient countries

“…For example, the firstgeneration panel unit root tests methodologies (Maddala and Wu, 1999;Levin et al 2002;Im et al 2003) based on the assumption of the cross-sectional independence across units; the secondgeneration unit root tests methodologies (Bai and Ng, 2004;Smith et al 2004;Moon and Perron, 2004;Choi, 2006;Pesaran, 2007) with the assumption of cross-sectional dependence across units, and finally, panel unit root test methodologies those accounts for structural breaks in the panel. Therefore, this study initially employs cross section dependence (CD) test developed by Pesaran (2004) test to investigate contemporaneous correlation across countries and to appreciate the types of unit root test to be applied and the types of cointegrating methodology to be persuaded.…”

Fiscal policy and TFP in the OECD: measuring direct and indirect effects

“…In this section we analyze the time series properties of each of the variables used. Panel unit root tests allowing for cross-sectional dependence have been proposed by, most notably, Pesaran (2007), Moon and Perron (2004) and Bai and Ng (2004). These tests are similar in that they assume an observed variable x it to have the following common factor structure…”