On the Panel Unit Root Tests Using Nonlinear Instrumental Variables

14 Pages Posted: 1 Jan 2004

See all articles by Kyung So Im

Kyung So Im

University of Central Florida - College of Business Administration

M. Hashem Pesaran

University of Southern California - Department of Economics

Date Written: October 2003

Abstract

This paper re-examines the panel unit root tests proposed by Chang (2002). She establishes asymptotic independence of the t-statistics when integrable functions of lagged dependent variable are used as instruments even if the original series are cross sectionally dependent. From this rather remarkable result she claims that her non-linear instrumental variable (NIV) panel unit root test is valid under general error cross correlations for any N (the cross section dimension) as T (the time dimension of the panel) tends to infinity. We show that her claim is valid only if NlnT/square root of T to 0, as N and T to infinity, and this condition is unlikely to hold in practice, unless N is very small. The favourable simulation results reported by Chang are largely due to her particular choice of the error correlation matrix, which results in weak cross section dependence. Also, the asymptotic independence property of the t-statistics disappears when Chang's modified instruments are used. Using a common factor model with a sizeable degree of cross section correlations, we are able to show that Chang's NIV panel unit root test suffers from gross size distortions, even when N is small relative to T (for example N=5, T=100).

Keywords: Non-linear Instrumental Variable (NIV) Panel unit root tests, Cross-section dependence, Finite sample properties

JEL Classification: C12, C15, C22, C23

Suggested Citation

Im, Kyung So and Pesaran, M. Hashem, On the Panel Unit Root Tests Using Nonlinear Instrumental Variables (October 2003). Available at SSRN: https://ssrn.com/abstract=482463 or http://dx.doi.org/10.2139/ssrn.482463

Kyung So Im

University of Central Florida - College of Business Administration ( email )

PO Box 161400
Orlando, FL 32816
United States

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics ( email )

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

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