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

56 Pages Posted: 23 May 2008

See all articles by M. Hashem Pesaran

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

L. Vanessa Smith

University of York - Department of Economics and Related Studies

Takashi Yamagata

University of York - Department of Economics and Related Studies; Osaka University - Institute of Social and Economic Research

Multiple version iconThere are 2 versions of this paper

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: panel unit root tests, cross section dependence, multi-factor residual structure, Fisher inflation parity, real equity prices

JEL Classification: C12, C15, C22, C23

Suggested Citation

Pesaran, M. Hashem and Smith, L. Vanessa and Yamagata, Takashi, Panel Unit Root Tests in the Presence of a Multifactor Error Structure. IZA Working Paper No. 3254, Available at SSRN: https://ssrn.com/abstract=1136416 or http://dx.doi.org/10.1111/j.0042-7092.2007.00700.x

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

L. Vanessa Smith

University of York - Department of Economics and Related Studies ( email )

Heslington
University of York
York, YO10 5DD
United Kingdom

Takashi Yamagata

University of York - Department of Economics and Related Studies ( email )

Heslington
York, YO1 5DD
United Kingdom

Osaka University - Institute of Social and Economic Research ( email )

6-1, Mihogaoka
Suita, Osaka 567-0047
Japan

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
32
Abstract Views
487
PlumX Metrics