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ESTIMATION AND INFERENCE IN SHORT PANEL VECTOR AUTOREGRESSIONS WITH UNIT ROOTS AND COINTEGRATION

Published online by Cambridge University Press:  19 July 2005

Michael Binder ,
Cheng Hsiao  and
M. Hashem Pesaran
Michael Binder
Affiliation:
Goethe University Frankfurt
Cheng Hsiao
Affiliation:
University of Southern California
M. Hashem Pesaran
Affiliation:
Cambridge University and University of Southern California
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Abstract

This paper considers estimation and inference in panel vector autoregressions where (i) the individual effects are either random or fixed, (ii) the time-series properties of the model variables are unknown a priori and may feature unit roots and cointegrating relations, and (iii) the time dimension of the panel is short and its cross-sectional dimension is large. Generalized method of moments (GMM) and quasi maximum likelihood (QML) estimators are obtained and compared in terms of their asymptotic and finite-sample properties. It is shown that the asymptotic variances of the GMM estimators that are based on levels in addition to first differences of the model variables depend on the variance of the individual effects, whereas by construction the fixed effects QML estimator is not subject to this problem. Monte Carlo evidence is provided showing that the fixed effects QML estimator tends to outperform the various GMM estimators in finite sample under both normal and nonnormal errors. The paper also shows how the fixed effects QML estimator can be successfully used for unit root and cointegration tests in short panels.We are grateful to Karim Abadir, Stephen Bond, Jinyong Hahn, Marc Nerlove, Ingmar Prucha, and, especially, Manuel Arellano, Peter Schmidt, Peter Phillips (the editor), and four anonymous referees for helpful and constructive comments. We have also benefited from useful suggestions by participants at various seminars and conferences.

Type
Research Article
Information
Econometric Theory , Volume 21 , Issue 4 , August 2005 , pp. 795 - 837
Copyright
© 2005 Cambridge University Press

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