A RESIDUAL-BASED TEST OF THE NULL OF COINTEGRATION IN PANEL DATA

This paper proposes a residual-based Lagrange Multiplier (LM) test for the null of cointegration in panel data. The test is analogous to the locally best unbiased invariant (LBUI) for a moving average (MA) unit root. The asymptotic distribution of the test is derived under the null. Monte Carlo simulations are performed to study the size and power properties of the proposed test. Overall, the empirical sizes of the LM- FM and LM-DOLS are close to the true size even in small samples. The power is quite good for the panels where T >50, and decent with panels for fewer observations in T. In our fixed sample of N=50 and T=50, the presence of a moving average and correlation between the regressor errors and regressors causes the two tests to perform quite differently, complicating the choice of estimation procedures. In general, the LM- DOLS test seems to be better at correcting these effects, although in some cases the LM-FM test is more powerful. Although much of the non- stationary time series econometrics has been criticized for having more to do with the specific properties of the data set rather than underlying economic models, the recent development of the cointegration literature has allowed for a concrete bridge between economic long run theory and time series methods. Our test now allows for the testing of the null of cointegration in a panel setting and should be of considerable interest to economists in a wide variety of fields.