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On the use of panel unit root tests on cross-sectionally dependent data: an application to PPP

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  • Fabian BORNHORST

Abstract

A Monte Carlo exercise demonstrates the different size distortions that two of the most commonly used panel unit root tests have when the sections of the panel are affected by correlated errors, when they are cointegrated, or both. For a specific form of sectional correlation, the limiting distribution is derived and asymptotic normality of the test statistic is established. To determine the nature of contemporaneous cross-sectional correlation in real data, covariance matrix estimation techniques are discussed and an appropriate bootstrap method for the estimation of standard errors is suggested. In an application to a panel of real exchange rates it is found that both aforementioned dependencies are present, and therefore the results of panel unit root tests if applied at all should be interpreted accordingly.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2003/24.

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Date of creation: 2003
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Handle: RePEc:eui:euiwps:eco2003/24

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Keywords: panel data; nonstationarity; cross-sectional dependence; PPP;

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Cited by:
  1. Fabio Busetti & Silvia Fabiani & Andrew Harvey, 2006. "Convergences of prices and rates of inflation," Temi di discussione (Economic working papers) 575, Bank of Italy, Economic Research and International Relations Area.
  2. Martin Berka, 2009. "Nonlinear Adjustment in Law of One Price Deviations and Physical Characteristics of Goods," Review of International Economics, Wiley Blackwell, vol. 17(1), pages 51-73, 02.
  3. Sanchirico, James & Newell, Richard & Papps, Kerry, 2005. "Asset Pricing in Created Markets for Fishing Quotas," Discussion Papers dp-05-46, Resources For the Future.
  4. Österholm, Pär, 2004. "Estimating the Relationship between Age Structure and GDP in the OECD Using Panel Cointegration Methods," Working Paper Series 2004:13, Uppsala University, Department of Economics.

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