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On the use of panel unit root tests on cross-sectionally dependent data: an application to PPP


  • Fabian BORNHORST


A Monte Carlo exercise demonstrates the different size distortions that two of the most commonly used panel unit root tests have when the sections of the panel are affected by correlated errors, when they are cointegrated, or both. For a specific form of sectional correlation, the limiting distribution is derived and asymptotic normality of the test statistic is established. To determine the nature of contemporaneous cross-sectional correlation in real data, covariance matrix estimation techniques are discussed and an appropriate bootstrap method for the estimation of standard errors is suggested. In an application to a panel of real exchange rates it is found that both aforementioned dependencies are present, and therefore the results of panel unit root tests if applied at all should be interpreted accordingly.

Suggested Citation

  • Fabian BORNHORST, 2003. "On the use of panel unit root tests on cross-sectionally dependent data: an application to PPP," Economics Working Papers ECO2003/24, European University Institute.
  • Handle: RePEc:eui:euiwps:eco2003/24

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    References listed on IDEAS

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    Cited by:

    1. Fabio Busetti & Silvia Fabiani & Andrew Harvey, 2006. "Convergence of Prices and Rates of Inflation," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 68(s1), pages 863-877, December.
    2. Martin Berka, 2009. "Nonlinear Adjustment in Law of One Price Deviations and Physical Characteristics of Goods," Review of International Economics, Wiley Blackwell, vol. 17(1), pages 51-73, February.
    3. Österholm, Pär, 2004. "Estimating the Relationship between Age Structure and GDP in the OECD Using Panel Cointegration Methods," Working Paper Series 2004:13, Uppsala University, Department of Economics.
    4. Sanchirico, James & Newell, Richard & Papps, Kerry, 2005. "Asset Pricing in Created Markets for Fishing Quotas," Discussion Papers dp-05-46, Resources For the Future.

    More about this item


    panel data; nonstationarity; cross-sectional dependence; PPP;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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