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Spurious Regression and Residual-Based Tests for Cointegration in Panel Data When the Cross-Section and Time-Series Dimensions are Comparable

  • Chihwa Kao

    (Syracuse University)

In the first half of the paper we study spurious regressions in panel data when the cross-section and time-series dimensions are comparable. Asymptotic properties of the least-squares dummy variable (LSDV) estimator and other conventional statistics are examined. We show that the LSDV estimatoris consistent for its true value, but the t-statistic diverges so that inferences about the regression coefficient, are wrong with the probability that goes to one. The asymptotics of LSDV are also different from those of the spurious regression in the pure time series. This has an important consequence for residual-based cointegration tests in panel data, because the null distribution of residual-based cointegration tests depends on the asymptotics of LSDV. In the second half of the paper we study residual-based tests for cointegration regression in panel data. We study Dickey-Fuller (DF) tests and an augmented Dickey-Fuller (ADF) test to test the null of no cointegration. Asymptotic distributions of the tests a re derived and Monte Carlo experiments are conducted to evaluate finite sample properties of the proposed tests.

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Paper provided by EconWPA in its series Econometrics with number 9703002.

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Length: 45 pages
Date of creation: 17 Mar 1997
Date of revision:
Handle: RePEc:wpa:wuwpem:9703002
Note: Type of Document - Tex (DVI); prepared on PC-TEX; to print on HP/PostScript; pages: 45 ; figures: 0
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  1. Peter C.B. Phillips, 1985. "Time Series Regression with a Unit Root," Cowles Foundation Discussion Papers 740R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1986.
  2. Pesaran, M.H. & Smith, R., 1992. "Estimating Long-Run Relationships From Dynamic Heterogeneous Panels," Cambridge Working Papers in Economics 9215, Faculty of Economics, University of Cambridge.
  3. Phillips, P.C.B., 1986. "Understanding spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 33(3), pages 311-340, December.
  4. Peter C.B. Phillips & Sam Ouliaris, 1987. "Asymptotic Properties of Residual Based Tests for Cointegration," Cowles Foundation Discussion Papers 847R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1988.
  5. 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.
  6. Danny Quah, 1993. "Exploiting Cross Section Variation for Unit Root Inference in Dynamic Data," FMG Discussion Papers dp171, Financial Markets Group.
  7. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
  8. Park, J.Y. & Ogaki, M., 1991. "Seemingly Unrelated Canonical Cointegrating Regressions," RCER Working Papers 280, University of Rochester - Center for Economic Research (RCER).
  9. Haug, Alfred A., 1996. "Tests for cointegration a Monte Carlo comparison," Journal of Econometrics, Elsevier, vol. 71(1-2), pages 89-115.
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