On the Estimation and Inference of a Panel Cointegration Model with Cross-Sectional Dependence

Syracuse University Center for Policy Research Working Paper No. 75

33 Pages Posted: 20 Apr 2011

See all articles by Jushan Bai

Jushan Bai

New York University (NYU) - Department of Economics

Chihwa Kao

Syracuse University

Date Written: December 1, 2005

Abstract

Most of the existing literature on panel data cointegration assumes cross-sectional independence, an assumption that is difficult to satisfy. This paper studies panel cointegration under cross-sectional dependence, which is characterized by a factor structure. We derive the limiting distribution of a fully modified estimator for the panel cointegrating coefficients. We also propose a continuous-updated fully modified (CUP-FM) estimator. Monte Carlo results show that the CUP-FM estimator has better small sample properties than the two-step FM (2S-FM) and OLS estimators.

Keywords: panel data cointegration, cross-sectional independence, cross-sectional dependence, continuous updated fully modified (CUP-FM) estimator, Monte Carlo results, two-step FM (2S-FM) estimator, OLS estimator

JEL Classification: C13, C15, C23

Suggested Citation

Bai, Jushan and Kao, Chihwa D., On the Estimation and Inference of a Panel Cointegration Model with Cross-Sectional Dependence (December 1, 2005). Syracuse University Center for Policy Research Working Paper No. 75, Available at SSRN: https://ssrn.com/abstract=1815227 or http://dx.doi.org/10.2139/ssrn.1815227

Jushan Bai

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10003
United States

Chihwa D. Kao (Contact Author)

Syracuse University ( email )

900 S. Crouse Avenue
426 Eggers Hall Maxwell School of Citizenship and Public Affairs
Syracuse, NY 13244
United States
315-443-3233 (Phone)
315-443-1081 (Fax)

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