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Testing for Unit Roots in Small Panels with Short-run and Long-run Cross-sectional Dependencies

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  • Yoosoon Chang
  • Wonho Song

Abstract

An IV approach, using as instruments non-linear transformations of the lagged levels, is explored to test for unit roots in panels with general dependency and heterogeneity across cross-sectional units. We allow not only for the cross-sectional dependencies of innovations, but also for the presence of co-integration across cross-sectional levels. Unbalanced panels and panels with differing individual short-run dynamics and cross-sectionally related dynamics are also permitted. We also more carefully formulate the unit root hypotheses in panels. In particular, using order statistics, we make it possible to test for and against the presence of unit roots in some of the individual units for a given panel. The individual IV t-ratios, which are the bases of our tests, are asymptotically and normally distributed and cross-sectionally independent. Therefore, the critical values of the order statistics as well as the usual average statistic can be easily obtained from simple elementary probability computations. We show via a set of simulations that our tests work well, whereas other existing tests fail to perform properly. As an illustration, we apply our tests to the panels of real exchange rates, and find no evidence for the purchasing power parity hypothesis, which is in sharp contrast with the previous studies. Copyright , Wiley-Blackwell.

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File URL: http://hdl.handle.net/10.1111/j.1467-937X.2009.00549.x
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Article provided by Oxford University Press in its journal The Review of Economic Studies.

Volume (Year): 76 (2009)
Issue (Month): 3 ()
Pages: 903-935

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Handle: RePEc:oup:restud:v:76:y:2009:i:3:p:903-935
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Cited by:

  1. Jaunky, Vishal Chandr, 2012. "Is there a material Kuznets curve for aluminium? evidence from rich countries," Resources Policy, Elsevier, vol. 37(3), pages 296-307.
  2. Matei Demetrescu & Christoph Hanck, 2013. "Nonlinear IV panel unit root testing under structural breaks in the error variance," Statistical Papers, Springer, vol. 54(4), pages 1043-1066, November.
  3. Ho, Tsung-wu, 2015. "Income inequality may not converge after all: Testing panel unit roots in the presence of cross-section cointegration," The Quarterly Review of Economics and Finance, Elsevier, vol. 56(C), pages 68-79.
  4. Palm Franz C. & Smeekes Stephan & Urbain Jean-Pierre, 2008. "Cross-Sectional Dependence Robust Block Bootstrap Panel Unit Root Tests," Research Memorandum 048, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  5. Vishal Jaunky, 2013. "Democracy and economic growth in Sub-Saharan Africa: a panel data approach," Empirical Economics, Springer, vol. 45(2), pages 987-1008, October.
  6. Kang, Wensheng, 2011. "Housing price dynamics and convergence in high-tech metropolitan economies," The Quarterly Review of Economics and Finance, Elsevier, vol. 51(3), pages 283-291, June.
  7. Matei Demetrescu & Christoph Hanck & Adina I. Tarcolea, 2014. "Iv-Based Cointegration Testing In Dependent Panels With Time-Varying Variance," Journal of Time Series Analysis, Wiley Blackwell, vol. 35(5), pages 393-406, 08.
  8. Eiji Kurozumi & Daisuke Yamazaki & Kaddour Hadri, 2013. "Covariate Unit Root Test for Cross-Sectionally Dependent Panel Data," Working Papers 13-01, Queen's University Management School.
  9. Francesca Di Iorio & Stefano Fachin, 2012. "Savings and Investments in the OECD: a panel cointegration study with a new bootstrap test," DSS Empirical Economics and Econometrics Working Papers Series 2012/2, Centre for Empirical Economics and Econometrics, Department of Statistics, "Sapienza" University of Rome.
  10. Snaith, Stuart, 2012. "The PPP debate: Multiple breaks and cross-sectional dependence," Economics Letters, Elsevier, vol. 115(3), pages 342-344.
  11. Costantini, Mauro & Lupi, Claudio, 2011. "A Simple Panel-CADF Test for Unit Roots," Economics Series 261, Institute for Advanced Studies.
  12. Yiannis Karavias & Elias Tzavalis, . "Testing for unit roots in panels with structural changes, spatial and temporal dependence when the time dimension is finite," Discussion Papers 14/03, University of Nottingham, Granger Centre for Time Series Econometrics.
  13. Christopoulos, Dimitris & McAdam, Peter, 2015. "Do financial reforms help stabilize inequality?," Working Paper Series 1780, European Central Bank.
  14. Vishal Chandr Jaunky & Robert Lundmark, 2015. "Are Shocks to Wood Fuel Production Permanent? Evidence from the EU," Energies, MDPI, Open Access Journal, vol. 8(11), pages 12335, November.
  15. Jaunky, Vishal Chandr, 2013. "A cointegration and causality analysis of copper consumption and economic growth in rich countries," Resources Policy, Elsevier, vol. 38(4), pages 628-639.
  16. Eiji Kurozumi & Daisuke Yamazaki & Kaddour Hadri, 2012. "Covariate Unit Root Test for Cross-Sectionally Dependent Panel Data," Global COE Hi-Stat Discussion Paper Series gd12-256, Institute of Economic Research, Hitotsubashi University.
  17. Iorio, Francesca Di & Fachin, Stefano, 2014. "Savings and investments in the OECD, 1970–2007: A test of panel cointegration with regime changes," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 59-76.

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