Testing for a Unit Root in Panels with Dynamic Factors

42 Pages Posted: 30 Apr 2003

See all articles by Hyungsik Roger Moon

Hyungsik Roger Moon

University of Southern California - Department of Economics; USC Dornsife Institute for New Economic Thinking

Benoit Perron

University of Montreal - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO); University of Montreal - Center for Interuniversity Research in Econometrics

Multiple version iconThere are 2 versions of this paper

Date Written: April 2003

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.

Note: An earlier version of this paper can be found at: http://ssrn.com/abstract=296229

Suggested Citation

Moon, Hyungsik Roger and Perron, Benoit, Testing for a Unit Root in Panels with Dynamic Factors (April 2003). Available at SSRN: https://ssrn.com/abstract=400720 or http://dx.doi.org/10.2139/ssrn.400720

Hyungsik Roger Moon (Contact Author)

University of Southern California - Department of Economics ( email )

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USC Dornsife Institute for New Economic Thinking ( email )

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Benoit Perron

University of Montreal - Department of Economics ( email )

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Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

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University of Montreal - Center for Interuniversity Research in Econometrics ( email )

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Montreal, Quebec H3C 3J7
Canada

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