A simple panel unit root test in the presence of cross-section dependence
Article first published online: 18 APR 2007
Copyright © 2007 John Wiley & Sons, Ltd.
Journal of Applied Econometrics
Special Issue: Heterogeneity and Cross Section Dependence in Panel Data Models: Theory and Application
Volume 22, Issue 2, pages 265–312, March 2007
How to Cite
Pesaran, M. H. (2007), A simple panel unit root test in the presence of cross-section dependence. J. Appl. Econ., 22: 265–312. doi: 10.1002/jae.951
- Issue published online: 18 APR 2007
- Article first published online: 18 APR 2007
- Manuscript Revised: 19 OCT 2006
- Manuscript Received: 31 JAN 2005
A number of panel unit root tests that allow for cross-section dependence have been proposed in the literature that use orthogonalization type procedures to asymptotically eliminate the cross-dependence of the series before standard panel unit root tests are applied to the transformed series. In this paper we propose a simple alternative where the standard augmented Dickey–Fuller (ADF) regressions are augmented with the cross-section averages of lagged levels and first-differences of the individual series. New asymptotic results are obtained both for the individual cross-sectionally augmented ADF (CADF) statistics and for their simple averages. It is shown that the individual CADF statistics are asymptotically similar and do not depend on the factor loadings. The limit distribution of the average CADF statistic is shown to exist and its critical values are tabulated. Small sample properties of the proposed test are investigated by Monte Carlo experiments. The proposed test is applied to a panel of 17 OECD real exchange rate series as well as to log real earnings of households in the PSID data. Copyright © 2007 John Wiley & Sons, Ltd.