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Panel Unit Root Tests in the Presence of a Multifactor Error Structure

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Author Info
M. Hashem Pesaran, L. Vanessa Smith, Takashi Yamagata

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Abstract

This paper extends the cross sectionally augmented panel unit root test proposed by Pesaran (2007) to the case of a multifactor structure. The basic idea is to exploit information regarding the unobserved factors that are shared by other time series in addition to the variable under consideration. Importantly, our test procedure only requires specification of the maximum number of factors, in contrast to other panel unit root tests based on principal components that require in addition the estimation of the number of factors as well as the factors themselves. Small sample properties of the proposed test are investigated by Monte Carlo experiments, which suggest that it controls well for size in almost all cases, especially in the presence of serial correlation in the error term, contrary to alternative test statistics. Empirical applications to Fisher's inflation parity and real equity prices across different markets illustrate how the proposed test works in practice.

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File URL: http://www.york.ac.uk/depts/econ/documents/dp/0803.pdf
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Publisher Info
Paper provided by Department of Economics, University of York in its series Discussion Papers with number 08/03.

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Date of creation: Mar 2008
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Handle: RePEc:yor:yorken:08/03

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Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom
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Related research
Keywords: Panel unit root tests; Cross Section Dependence; Multi-factor Residual Structure; Fisher Inflation Parity; Real Equity Prices.;

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Find related papers by JEL classification:
C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing
C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Statistical Simulation Methods
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data

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  1. Holly, Sean & Petrella, Ivan, 2009. "Factor Demand Linkages, Technology Shocks and the Business Cycle," MPRA Paper 18120, University Library of Munich, Germany. [Downloadable!]
  2. Holly, S. & Petrella, I., 2008. "Factor demand linkages and the business cycle: Interpreting aggregate fluctuations as sectoral fluctuations," Cambridge Working Papers in Economics 0827, Faculty of Economics, University of Cambridge. [Downloadable!]
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