A Simple Panel Unit Root Test in the Presence of Cross Section Dependence

61 Pages Posted: 2 Jan 2004

See all articles by M. Hashem Pesaran

M. Hashem Pesaran

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

Date Written: September 24, 2003

Abstract

A number of panel unit root tests that allow for cross section dependence have been proposed in the literature, notably by Bai and Ng (2002), Moon and Perron (2003), and Phillips and Sul (2002) who use orthogonalization type procedures to asymptotically eliminate the cross dependence of the series before standard panel unit root tests are applied to the transformed series. In this paper we propose a simple alternative test where the standard DF (or ADF) regressions are augmented with the cross section averages of lagged levels and first-differences of the individual series. A truncated version of the CADF statistics is also considered. New asymptotic results are obtained both for the individual CADF statistics, and their simple averages. It is shown that the CADF_i statistics are asymptotically similar and do not depend on the factor loadings under joint asymptotics where N (cross section dimension) and T (time series dimension) tends to infinity, such that N/T tends to k, where k is a fixed finite non-zero constant. But they are asymptotically correlated due to their dependence on the common factor. Despite this it is shown that the limit distribution of the average CADF statistic exists and its critical values are tabulated. The small sample properties of the proposed tests are investigated by Monte Carlo experiments, for a variety of models. It is shown that the cross sectionally augmented panel unit root tests have satisfactory size and power even for relatively small values of N and T. This is particularly true of cross sectionally augmented and truncated versions of the simple average t-test of Im, Pesaran and Shin, and Choi's inverse normal combination test.

Keywords: Panel unit root tests, Cross-section dependence, Heterogeneous dynamic panels, Finite sample properties

JEL Classification: C12, C15, C22, C23

Suggested Citation

Pesaran, M. Hashem, A Simple Panel Unit Root Test in the Presence of Cross Section Dependence (September 24, 2003). Available at SSRN: https://ssrn.com/abstract=457280 or http://dx.doi.org/10.2139/ssrn.457280

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

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