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Unit Root Tests for Panels in the Presence of Short-run and Long-run Dependencies: Nonlinear IV Approach with Fixed N and Large T

  • Chang, Yoosoon

    (Rice U)

  • Song, Wonho

    (Korea Institute for International Economic Policy)

An IV approach, using as instruments nonlinear 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 cointegration across cross-sectional levels. Unbalanced panels and panels with differing individual short-run dynamics and cross-sectionally related dynamics are also permitted. Panels with such cross-sectional dependencies and heterogeneities appear to be quite commonly observed in practical applications. Yet, none of the currently available tests can be used to test for unit roots in such general panels. 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 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, while 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.

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File URL: http://www.ruf.rice.edu/~econ/papers/2002papers/06Chang.pdf
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Paper provided by Rice University, Department of Economics in its series Working Papers with number 2002-06.

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Date of creation: Jan 2005
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Handle: RePEc:ecl:riceco:2002-06
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  1. Pasaran, M.H. & Im, K.S. & Shin, Y., 1995. "Testing for Unit Roots in Heterogeneous Panels," Cambridge Working Papers in Economics 9526, Faculty of Economics, University of Cambridge.
  2. Park, Joon, 2002. "Bootstrap Unit Root Tests," Working Papers 2003-04, Rice University, Department of Economics.
  3. Jushan Bai & Serena Ng, 2000. "Determining the Number of Factors in Approximate Factor Models," Boston College Working Papers in Economics 440, Boston College Department of Economics.
  4. Banerjee, Anindya, 1999. " Panel Data Unit Roots and Cointegration: An Overview," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(0), pages 607-29, Special I.
  5. Chang, Yoosoon, 2002. "Nonlinear IV unit root tests in panels with cross-sectional dependency," Journal of Econometrics, Elsevier, vol. 110(2), pages 261-292, October.
  6. Yoosoon Chang, 2000. "Bootstrap Unit Root Tests in Panels with Cross-Sectional Dependency," Econometric Society World Congress 2000 Contributed Papers 1585, Econometric Society.
  7. Badi H. Baltagi & Chihwa Kao, 2000. "Nonstationary Panels, Cointegration in Panels and Dynamic Panels: A Survey," Center for Policy Research Working Papers 16, Center for Policy Research, Maxwell School, Syracuse University.
  8. Peter C.B. Phillips & Joon Y. Park, 1998. "Asymptotics for Nonlinear Transformations of Integrated Time Series," Cowles Foundation Discussion Papers 1182, Cowles Foundation for Research in Economics, Yale University.
  9. 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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