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Dynamic factor extraction of cross‐sectional dependence in panel unit root tests
Author(s) -
Kapetanios George
Publication year - 2007
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.943
Subject(s) - uncorrelated , unit root , monte carlo method , econometrics , statistics , factor analysis , mathematics , computer science
Recently, considerable emphasis has been placed on the problems arising out of cross‐sectional dependence in panel unit root tests. This paper adopts the factor‐based cross‐sectional dependence paradigm of Bai and Ng (2005) but suggests alternative factor extraction methods. Some theoretical results for these methods are provided. Further, a detailed Monte Carlo study of these methods for multiple and persistent factors is undertaken. It is found that results are radically different from the serially uncorrelated single‐factor case. Tests perform much worse and in some cases it is preferable not to correct at all for cross‐sectional dependence. Copyright © 2007 John Wiley & Sons, Ltd.