Scandinavian Working Papers in Economics

HUI Working Papers,
HUI Research

No 72: Testing for Panel Cointegration in an Error Correction Framework - with an Application to the Fisher Hypothesis

Kristofer Månsson (), Ghazi Shukur () and Pär Sjölander
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Kristofer Månsson: Department of Economics, Finance and Statistics, Postal: Jönköping University, Sweden
Ghazi Shukur: Department of Economics, Finance and Statistics, Postal: Jönköping University, Sweden, and HUI Research, Regeringsgatan 60, 103 29 Stockholm
Pär Sjölander: Department of Economics, Finance and Statistics, Postal: Jönköping University, Sweden,

Abstract: In this paper, three innovative panel error correction model (PECM) tests are proposed. These tests are based on the multivariate versions of the Wald (W), Likelihood Ratio (LR) and Lagrange Multiplier (LM) tests. By means of Monte Carlo simulations, the size and power properties of the tests are investigated when the error terms exhibit both cross-sectional dependence and independence. We find that the LM test is the best option when the error terms follow independent white-noise processes. However, regarding the more empirically relevant case of cross-sectional dependence, we conclude that the W test is the optimal choice. In contrast to previous studies, our method is general and does not rely on the strict assumption that a common factor causes the cross-sectional dependency. In an empirical application our method is also demonstrated as regards to the Fisher effect – a hypothesis about whose existence is still no clear consensus. Based on a sample of the Nordic countries, we utilize our powerful test and discover evidence which, in contrast to most previous research, confirms the Fisher effect.

Keywords: Panel Cointegration; Error Correction; Fisher Hypothesis; Multivariate Tests; Size and Power

JEL-codes: C40

16 pages, October 31, 2012

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