Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2003:10: Cross-sectional dependency and size distortion in a small-sample homogeneous panel-data unit root test

Kristian Jönsson ()
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Kristian Jönsson: Sveriges Riksbank, Postal: Macroprudential Division, Financial Stability Department, Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: In this paper, we investigate the effects of cross-sectional disturbance correlation in a homogenous panel-data unit root test. As reported by other authors, the unit root test has incorrect size in the presence of cross-sectional correlation. We suggest that a previously known estimator can be used to reduce the size distortions. We supply response surface estimates for critical values and study the size characteristics of the proposed test. We find that the suggested estimator performs well in small-sample homogenous panel-data unit root tests. The reduction in size distortion comes at small cost of lower power against a stationary alternative.

Keywords: Panel Data; Unit Root; Private Consumption

JEL-codes: C23; E21

23 pages, July 11, 2003

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