Testing for unit roots and cointegration in heterogeneous panels
This thesis undertakes a Monte Carlo study to investigate the finite sample properties of several panel unit root and cointegration tests. To this end, we consider a number of different experiments which potentially affect the properties of the tests. We first consider panel unit root tests in heterogenous panels. Application of the panel tests of Im, Pesaran and Shin (2003) (IPS), and Maddala and Wu (1999) (MW) increases their power over the standard ADF test. However, the power of the tests is significantly diminished when the panel is dominated by the non-stationary series. Neglecting the presence of cross-sectional dependence results in serious size distortions. In view of this, a variety of methods are applied to correct the size distortions. However, the power of all tests is diminished as the cross-correlations reduce the amount of independent information in the panel. The simulation results from the panel cointegration tests extend the findings of the unit root tests to multivariate cases. The likelihood-based panel rank test of Larsson, Lyhagen and Lothgren (2001) is found to be more powerful than the residual-based panel tests of IPS and MW, but slightly oversized in moderate sample sizes (Z). The effects of a mixed panel and of cross-correlations in the errors are similar to those of panel unit root tests. Therefore, we again, use the bootstrap method and the Cross-sectionally augmented IPS test (CIPS) ofPesaran (2003) to correct the size distortions. The presence of structural breaks affects the size and power properties of any panel unit root tests which fail to cope with it. When the break dates are known, the exogenous break panel LM test is applied, to control the effect of structural shifts. In addition, the endogenous break selection procedures are used to estimate the break points. The endogenous break panel LM test also performs considerably well in terms of the size, power and accuracy with which the true break points are estimated. Finally, application of the panel unit root and cointegration tests provide some evidence in support of the existence of long-run PPP and the monetary model in Asia Pacific countries. In addition, the presence of structural breaks as the impact of the currency crisis is also detected. However, evidence is found to be sensitive to the choice of deterministic terms (intercepts, trends), the methods used to estimate the panel test statistic (e.g. SUR and CIPS) and the break-point selection criteria.