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Rethinking the Univariate Approach to Panel Unit Root Testing: Using Covariates to Resolve the Incidental Trend Problem

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  • Joakim Westerlund

Abstract

In an influential article, Hansen showed that covariate augmentation can lead to substantial power gains when compared to univariate tests. In this article, we ask if this result extends also to the panel data context? The answer turns out to be yes, which is maybe not that surprising. What is surprising, however, is the extent of the power gain, which is shown to more than outweigh the well-known power loss in the presence of incidental trends. That is, the covariates have an order effect on the neighborhood around unity for which local asymptotic power is negligible.

Suggested Citation

  • Joakim Westerlund, 2015. "Rethinking the Univariate Approach to Panel Unit Root Testing: Using Covariates to Resolve the Incidental Trend Problem," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 33(3), pages 430-443, July.
    • Handle: RePEc:taf:jnlbes:v:33:y:2015:i:3:p:430-443
    DOI: 10.1080/07350015.2014.962697
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    References listed on IDEAS

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    1. Joakim Westerlund & Jörg Breitung, 2013. "Lessons from a Decade of IPS and LLC," Econometric Reviews, Taylor & Francis Journals, vol. 32(5-6), pages 547-591, August.
    2. Hyungsik R. Moon & Peter C. B. Phillip, 1999. "Maximum Likelihood Estimation in Panels with Incidental Trends," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(S1), pages 711-747, November.
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    14. 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.
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    Cited by:

    1. Yang, Yang & Zhao, Zhao, 2020. "Quantile nonlinear unit root test with covariates and an application to the PPP hypothesis," Economic Modelling, Elsevier, vol. 93(C), pages 728-736.

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