A Panic Attack on Unit Roots and Cointegration

Boston College Working Paper No. 519

40 Pages Posted: 23 Dec 2001

See all articles by Jushan Bai

Jushan Bai

New York University (NYU) - Department of Economics

Serena Ng

Columbia Business School - Economics Department

Date Written: December 2001

Abstract

This paper develops a new methodology that makes use of the factor structure of large dimensional panels to understand the nature of non-stationarity in the data. We refer to it as PANIC - a 'Panel Analysis of Non-stationarity in Idiosyncratic and Common components'. PANIC consists of univariate and panel tests with a number of novel features. It can detect whether the nonstationarity is pervasive, or variable-specific, or both. It tests the components of the data instead of the observed series. Inference is therefore more accurate when the components have different orders of integration. PANIC also permits the construction of valid panel tests even when cross-section correlation invalidates pooling of statistics constructed using the observed data. The key to PANIC is consistent estimation of the components even when the regressions are individually spurious. We provide a rigorous theory for estimation and inference. In Monte Carlo simulations, the tests have very good size and power. PANIC is applied to a panel of inflation series.

Keywords: Panel data, common factors, common trends, principal components

JEL Classification: C2, C3, C5

Suggested Citation

Bai, Jushan and Ng, Serena, A Panic Attack on Unit Roots and Cointegration (December 2001). Boston College Working Paper No. 519, Available at SSRN: https://ssrn.com/abstract=294808 or http://dx.doi.org/10.2139/ssrn.294808

Jushan Bai

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

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

Serena Ng (Contact Author)

Columbia Business School - Economics Department ( email )

420 West 118th Street
New York, NY 10027
United States

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