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Panel Cointegration Testing in the Presence of Common Factors

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Author Info
Gengenbach,Christian
Palm,Franz C.
Urbain,Jean-Pierre (METEOR)

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Abstract

Panel unit root and no-cointegration tests that rely on cross-sectional independence of the panel unit experience severe size distortions when this assumption is violated, as has e.g. been shown by Banerjee, Marcellino and Osbat (2004, 2005) via Monte Carlo simulations. Several studies have recently addressed this issue for panel unit root test using a common factor structure to model the cross-sectional dependence, but not much work has been done yet for panel no-cointegration tests. This paper proposes a model for panel no-cointegration using an unobserved common factor structure, following the work on Bai and Ng (2004) for panel unit roots. The model enables us to distinguish two important cases: (i) the case when the non-stationarity in the data is driven by a reduced number of common stochastic trends, and (ii) the case where we have common and idiosyncratic stochastic trends present in the data. We study the asymptotic behavior of some existing, residual-based panel no-cointegration, as suggested by Kao (1999) and Pedroni (1999, 2004). Under the DGP used, the test statistics are no longer asymptotically normal, and convergence occurs at rate T rather than sqrt(N)T as for independent panels. We then examine the properties of residual-based tests for no-cointegration applied to defactored data from which the common factors and individual components have been extracted.

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Paper provided by Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization in its series Research Memoranda with number 050.

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Date of creation: 2005
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Handle: RePEc:dgr:umamet:2005050

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Keywords: econometrics;

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Joerg Breitung & M. Hashem Pesaran, 2005. "Unit Roots and Cointegration in Panels," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  2. Jushan Bai & Serena Ng, 2004. "A PANIC Attack on Unit Roots and Cointegration," Econometrica, Econometric Society, vol. 72(4), pages 1127-1177, 07. [Downloadable!] (restricted)
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  3. Phillips, P C B & Durlauf, S N, 1986. "Multiple Time Series Regression with Integrated Processes," Review of Economic Studies, Blackwell Publishing, vol. 53(4), pages 473-95, August. [Downloadable!] (restricted)
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  4. Pesaran, M.H., 2003. "A Simple Panel Unit Root Test in the Presence of Cross Section Dependence," Cambridge Working Papers in Economics 0346, Faculty of Economics, University of Cambridge. [Downloadable!]
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  5. Stefano Fachin, 2005. "Long-Run Trends in Internal Migrations in Italy: a Study in Panel Cointegration with Dependent Units," Econometrics 0507002, EconWPA. [Downloadable!]
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  6. de Jong, Robert M. & Davidson, James, 2000. "The Functional Central Limit Theorem And Weak Convergence To Stochastic Integrals I," Econometric Theory, Cambridge University Press, vol. 16(05), pages 621-642, October. [Downloadable!]
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  7. MOON, Hyungsik Roger & PERRON, Benoit., 2002. "Testing for a Unit Root in Panels with Dynamic Factors," Cahiers de recherche 2002-18, Universite de Montreal, Departement de sciences economiques. [Downloadable!]
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  8. Andrews, Donald W K, 1991. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Econometrica, Econometric Society, vol. 59(3), pages 817-58, May. [Downloadable!] (restricted)
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  9. Alain Hecq & Franz Palm & Jean-Pierre Urbain, 2002. "Separation, Weak Exogeneity, And P-T Decomposition In Cointegrated Var Systems With Common Features," Econometric Reviews, Taylor and Francis Journals, vol. 21(3), pages 273-307. [Downloadable!] (restricted)
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  10. Urbain, Jean-Pierre & Westerlund, Joakim, 2006. "Spurious Regression in Nonstationary Panels with Cross-Unit Cointegration," Research Memoranda 057, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  11. Pedroni, Peter, 1999. " Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(0), pages 653-70, Special I. [Downloadable!] (restricted)
  12. Andrews, Donald W K & Monahan, J Christopher, 1992. "An Improved Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimator," Econometrica, Econometric Society, vol. 60(4), pages 953-66, July. [Downloadable!] (restricted)
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  13. Peter C. B. Phillips & Donggyu Sul, 2003. "Dynamic panel estimation and homogeneity testing under cross section dependence *," Econometrics Journal, Royal Economic Society, vol. 6(1), pages 217-259, 06. [Downloadable!] (restricted)
  14. Peter C.B. Phillips & Hyungsik R. Moon, 1999. "Linear Regression Limit Theory for Nonstationary Panel Data," Cowles Foundation Discussion Papers 1222, Cowles Foundation, Yale University. [Downloadable!]
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  15. Anindya Banerjee & Massimiliano Marcellino & Chiara Osbat, 2004. "Some cautions on the use of panel methods for integrated series of macroeconomic data," Econometrics Journal, Royal Economic Society, vol. 7(2), pages 322-340, December. [Downloadable!] (restricted)
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  16. Stéphane Dées & Filippo di Mauro & M. Hashem Pesaran & L. Vanessa Smith, 2005. "Exploring the international linkages of the euro area - a global VAR analysis," Working Paper Series 568, European Central Bank. [Downloadable!]
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  17. Martin Wagner & Georg Müller-Fürstenberger, 2004. "The Carbon Kuznets Curve: A Cloudy Picture Emitted by Bad Econometrics?," Diskussionsschriften dp0418, Universitaet Bern, Departement Volkswirtschaft. [Downloadable!]
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  18. Gengenbach,Christian & Palm,Franz & Urbain,Jean-Pierre, 2004. "Panel Unit Root Tests in the Presence of Cross-Sectional Dependencies: Comparison and Implications for Modelling," Research Memoranda 040, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  19. Kao, Chihwa, 1999. "Spurious regression and residual-based tests for cointegration in panel data," Journal of Econometrics, Elsevier, vol. 90(1), pages 1-44, May. [Downloadable!] (restricted)
  20. Levin, Andrew & Lin, Chien-Fu & James Chu, Chia-Shang, 2002. "Unit root tests in panel data: asymptotic and finite-sample properties," Journal of Econometrics, Elsevier, vol. 108(1), pages 1-24, May. [Downloadable!] (restricted)
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  21. Aznar, Antonio & Salvador, Manuel, 2002. "Selecting The Rank Of The Cointegration Space And The Form Of The Intercept Using An Information Criterion," Econometric Theory, Cambridge University Press, vol. 18(04), pages 926-947, August. [Downloadable!]
  22. Anindya Banerjee & Massimiliano Marcellino & Chiara Osbat, 2005. "Testing for PPP: Should we use panel methods?," Empirical Economics, Springer, vol. 30(1), pages 77-91, January. [Downloadable!] (restricted)
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  23. Westerlund, Joakim, 2005. "New Simple Tests for Panel Cointegration," Working Papers 2005:8, Lund University, Department of Economics.
  24. Lyhagen, Johan, 2000. "Why not use standard panel unit root test for testing PPP," Working Paper Series in Economics and Finance 413, Stockholm School of Economics. [Downloadable!]
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  25. Pasaran, M.H. & Im, K.S. & Shin, Y., 1995. "Testing for Unit Roots in Heterogeneous Panels," Cambridge Working Papers in Economics 9526, Faculty of Economics, University of Cambridge.
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jushan Bai & Chihwa Kao & Serena Ng, 2007. "Panel Cointegration with Global Stochastic Trends," Center for Policy Research Working Papers 90, Center for Policy Research, Maxwell School, Syracuse University. [Downloadable!]
    Other versions:
  2. Gengenbach, Christian & Urbain, Jean-Pierre & Westerlund, Joakim, 2008. "Panel Error Correction Testing with Global Stochastic Trends," Research Memoranda 051, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  3. Di Iorio, Francesca & Fachin, Stefano, 2006. "Testing for breaks in cointegrated panels," MPRA Paper 3280, University Library of Munich, Germany. [Downloadable!]
  4. Westerlund, Joakim & Basher, Syed A., 2006. "Can Panel Data Really Improve the Predictability of the Monetary Exchange Rate Model?," MPRA Paper 1229, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  5. Tino Berger & Gerdie Everaert, 2009. "A replication note on unemployment in the OECD since the 1960s: what do we know?," Empirical Economics, Springer, vol. 36(2), pages 479-485, May. [Downloadable!] (restricted)
  6. Urbain, Jean-Pierre & Westerlund, Joakim, 2006. "Spurious Regression in Nonstationary Panels with Cross-Unit Cointegration," Research Memoranda 057, Maastricht : METEOR, Maastricht Research School of Economics of Technology and Organization. [Downloadable!]
  7. Yongfu Huang, 2006. "Private investment and financial development in a globalized world," Bristol Economics Discussion Papers 06/589, Department of Economics, University of Bristol, UK. [Downloadable!]
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