Residual based tests for cointegration in dependent panels

In the paper, we propose residual based tests for cointegration in general panels with cross-sectional dependency, endogeneity and various heterogeneities. The residuals are obtained from the usual least squares estimation of the postulated cointegrating relationships from each individual unit, and the nonlinear IV panel unit root testing procedure is applied to the panels of the fitted residuals using as instruments the nonlinear transformations of the adaptively fitted lagged residuals. The t -ratio, based on the nonlinear IV estimator, is then constructed to test for unit root in the fitted residuals for each cross-section. We show that such nonlinear IV t -ratios are asymptotically normal and cross-sectionally independent under the null hypothesis of no cointegration. The average or the minimum of the IV t -ratios can, therefore, be used to test for the null of a fully non-cointegrated panel against the alternative of a mixed panel, i.e., a panel with only some cointegrated units. We also consider the maximum of the IV t -ratios to test for a mixed panel against a fully cointegrated panel. The critical values of the minimum, maximum as well as the average tests are easily obtained from the standard normal distribution function. Our simulation results indicate that the residual based tests for cointegration perform quite well in finite samples.