Estimation and Inference in Short Panel Vector Autoregressions with Unit Roots and Cointegration

65 Pages Posted: 28 Jan 2001

See all articles by M. Hashem Pesaran

M. Hashem Pesaran

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

Michael Binder

University of Maryland - Department of Economics

Cheng Hsiao

University of Southern California - Department of Economics; National Taiwan University; National Bureau of Economic Research (NBER)

Date Written: November 2000

Abstract

This paper considers estimation and inference in panel vector autoregressions (PVARs) with fixed effects when the time dimension of the panel is finite, and the cross-sectional dimension is large. A Maximum Likelihood (ML) estimator based on a transformed likelihood function is proposed and shown to be consistent and asymptotically normally distributed irrespective of the unit root and cointegrating properties of the underlying PVAR model. The transformed likelihood framework is also used to derive unit root and cointegration tests in panels with short time dimension; these tests have the attractive feature that they are based on standard chi-square and normal distributed statistics. Examining Generalized Method of Moments (GMM) estimation as an alternative to our proposed ML estimator, it is shown that conventional GMM estimators based on standard orthogonality conditons break down if the underlying time series contain unit roots. Also, the implementation of extended GMM estimators making use of variants of homoskedasticity and stationarity restrictions as suggested in the literature in a univariate context is subject to difficulties. Monte Carlo evidence is adduced suggesting that the ML estimator and parameter hypothesis and cointegration tests based on it perform well in small sample; this is in marked contrast to the small sample performance of the GMM estimators.

Keywords: Panel vector autoregressions, fixed effects, unit roots, cointegration

JEL Classification: C12, C13, C33

Suggested Citation

Pesaran, M. Hashem and Binder, Michael and Hsiao, Cheng, Estimation and Inference in Short Panel Vector Autoregressions with Unit Roots and Cointegration (November 2000). Available at SSRN: https://ssrn.com/abstract=257772

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

Michael Binder

University of Maryland - Department of Economics ( email )

Tydings Hall
College Park, MD 20742
United States

Cheng Hsiao

University of Southern California - Department of Economics ( email )

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

National Taiwan University

1 Sec. 4, Roosevelt Road
Taipei, 106
Taiwan

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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