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A Panel Unit Root Test with Good Power in Small Samples

  • Claude Lopez

    ()

We propose a new pooled panel unit root test allowing for serial and contemporaneous correlation. The new test combines Elliott, Rothenberg and Stock's (1996) local-to-unity transformation with a pooled panel ADF test. As initially advocated by O'Connell (1998), the new test accounts for contemporaneous correlation by estimating the residual covariance matrix. Monte Carlo simulations demonstrate significantly better finite sample power properties of the new test over a wide range of existing panel unit root tests accounting for cross-sectional correlation. Furthermore, enhanced performances are particularly noticeable when the series are highly persistent and the panels are relatively small. An application to the real exchange rate convergence illustrates the impact of such improvements. Analyzing the post Bretton Woods period, the new test provides strong and reliable rejections of the unit root among the real exchange rates of industrialized countries.

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Paper provided by University of Cincinnati, Department of Economics in its series University of Cincinnati, Economics Working Papers Series with number 2005-01.

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Length: 31 pages
Date of creation: 2005
Date of revision: 2007
Handle: RePEc:cin:ucecwp:2005-01
Contact details of provider: Postal: Cincinnati, OH 45221-0371
Phone: (513) 556-2670
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Web page: http://www.business.uc.edu/economics/
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  1. 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.
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  10. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July.
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  12. Sargan, John Denis & Bhargava, Alok, 1983. "Testing Residuals from Least Squares Regression for Being Generated by the Gaussian Random Walk," Econometrica, Econometric Society, vol. 51(1), pages 153-74, January.
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  22. Lopez, Claude & Murray, Christian J & Papell, David H, 2005. "State of the Art Unit Root Tests and Purchasing Power Parity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 361-69, April.
  23. Harris, Richard D. F. & Tzavalis, Elias, 1999. "Inference for unit roots in dynamic panels where the time dimension is fixed," Journal of Econometrics, Elsevier, vol. 91(2), pages 201-226, August.
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  25. Papell, David H., 1997. "Searching for stationarity: Purchasing power parity under the current float," Journal of International Economics, Elsevier, vol. 43(3-4), pages 313-332, November.
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  27. Papell, David H & Theodoridis, Hristos, 2001. "The Choice of Numeraire Currency in Panel Tests of Purchasing Power Parity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 790-803, August.
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