A number of panel unit root tests that allow for cross section dependence have been proposed in the literature, notably by Bai and Ng (2002), Moon and Perron (2003), and Phillips and Sul (2002) who use orthogonalization type procedures to asymptotically eliminate the cross dependence of the series before standard panel unit root tests are applied to the transformed series. In this paper we propose a simple alternative test where the standard DF (or ADF) regressions are augmented with the cross section averages of lagged levels and first-differences of the individual series. A truncated version of the CADF statistics is also considered. New asymptotic results are obtained both for the individual CADF statistics, and their simple averages. It is shown that the CADF_i statistics are asymptotically similar and do not depend on the factor loadings under joint asymptotics where N (cross section dimension) and T (time series dimension) tends to infinity, such that N/T tends to k, where k is a fixed finite non-zero constant. But they are asymptotically correlated due to their dependence on the common factor. Despite this it is shown that the limit distribution of the average CADF statistic exists and its critical values are tabulated. The small sample properties of the proposed tests are investigated by Monte Carlo experiments, for a variety of models. It is shown that the cross sectionally augmented panel unit root tests have satisfactory size and power even for relatively small values of N and T. This is particularly true of cross sectionally augmented and truncated versions of the simple average t-test of Im, Pesaran and Shin, and Choi's inverse normal combination test.

A Simple Panel Unit Root Test in the Presence of Cross Section Dependence

A number of panel unit root tests that allow for cross section dependence have been proposed in the literature that use orthogonalization type procedures to asymptotically eliminate the cross dependence of the series before standard panel unit root tests are applied to the transformed series. In this paper we propose a simple alternative where the standard ADF regressions are augmented with the cross section averages of lagged levels and first-differences of the individual series. New asymptotic results are obtained both for the individual CADF statistics, and their simple averages. It is shown that the individual CADF statistics are asymptotically similar and do not depend on the factor loadings. The limit distribution of the average CADF statistic is shown to exist and its critical values are tabulated. Small sample properties of the proposed test are investigated by Monte Carlo experiments. The proposed test is applied to a panel of 17 OECD real exchange rate series as well as to log real earnings of households in the PSID data.

https://onlinelibrary.wiley.com/doi/pdf/10.1002/jae.951

A simple panel unit root test in the presence of cross-section dependence

Offering a unifying theoretical perspective not readily available in any other text, this innovative guide to econometrics uses simple geometrical arguments to develop students' intuitive understanding of basic and advanced topics, emphasizing throughout the practical applications of modern theory and nonlinear techniques of estimation. One theme of the text is the use of artificial regressions for estimation, reference, and specification testing of nonlinear models, including diagnostic tests for parameter constancy, serial correlation, heteroscedasticity, and other types of mis-specification. Explaining how estimates can be obtained and tests can be carried out, the authors go beyond a mere algebraic description to one that can be easily translated into the commands of a standard econometric software package. Covering an unprecedented range of problems with a consistent emphasis on those that arise in applied work, this accessible and coherent guide to the most vital topics in econometrics today is indispensable for advanced students of econometrics and students of statistics interested in regression and related topics. It will also suit practising econometricians who want to update their skills. Flexibly designed to accommodate a variety of course levels, it offers both complete coverage of the basic material and separate chapters on areas of specialized interest.

Estimation and Inference in Econometrics

This paper studies risk attitudes using a large representative survey and a complementary experiment conducted with a representative subject pool in subjects’ homes. Using a question asking people about their willingness to take risks \"in general\", we find that gender, age, height, and parental background have an economically significant impact on willingness to take risks. The experiment confirms the behavioral validity of this measure, using paid lottery choices. Turning to other questions about risk attitudes in specific contexts, we find similar results on the determinants of risk attitudes, and also shed light on the deeper question of stability of risk attitudes across contexts. We conduct a horse race of the ability of different measures to explain risky behaviors such as holdings stocks, occupational choice, and smoking. The question about risk taking in general generates the best all-round predictor of risky behavior.

/pdf/individual-risk-attitudes-measurement-determinants-and-2j4cjvjdkm.pdf

Individual Risk Attitudes: Measurement, Determinants and Behavioral Consequences

The East Asian miracle: Economic growth and public policy: By the World Bank. (New York: Oxford University Press for the World Bank, 1993. 389 pp. $19.95, paper.)

This paper examines the link between income inequality and consumption inequality through the degree of insurance to income shocks. A new panel data consumption series is created for the PSID using an imputation procedure that maps food data into consumption data using the estimates of a demand function for food obtained from repeated CEX cross-sections. We document a disjuncture between income and consumption inequality in the US over the 1980s and show that it can be explained by changes in the persistence of income shocks. In particular, an initial growth in the variance of permanent shocks is then replaced by a continued growth in the variance of transitory income shocks. Although we find important differences in the degree of insurance by wealth, education, and birth cohort, the overall interpretation of the relationship between consumption and income inequality is maintained. We find some partial insurance of permanent income shocks with more insurance possibilities for the college educated and those approaching retirement. We find little evidence against full insurance for transitory income shocks except among low wealth households. Taxes and transfers as well as family labor supply are found to play an important role in insuring permanent shocks.

/pdf/consumption-inequality-and-partial-insurance-461kvtt5v2.pdf

Consumption inequality and partial insurance

We review different empirical approaches that researchers have taken to estimate how consumption responds to income changes. We critically evaluate the empirical evidence on the sensitivity of consumption to predicted income changes, distinguishing between the traditional excess sensitivity tests, and the effect of predicted income increases and income declines. We also review studies that attempt to estimate the marginal propensity to consume out of income shocks, distinguishing between three different approaches: identifying episodes in which income changes unexpectedly, relying on the covariance restrictions that the theory imposes on the joint behavior of consumption and income growth, and combining realizations and expectations of income or consumption in surveys where data on subjective expectations are available.

/pdf/the-consumption-response-to-income-changes-33ddf9s9ir.pdf

The Consumption Response to Income Changes

Recent theoretical work has shown the importance of measuring microeconomic uncertainty for models of both general and partial equilibrium under imperfect insurance. In this paper the assumption of i.i.d. income innovations used in previous empirical studies is removed and the focus of the analysis is placed on models for the conditional variance of income shocks, which is related to the measure of risk emphasized by the theory. We first discriminate amongst various models of earnings determination that separate income shocks into idiosyncratic transitory and permanent components. We allow for education- and time-specific differences in the stochastic process for earnings and for measurement error. The conditional variance of the income shocks is modelled as a parsimonious ARCH process with both observable and unobserved heterogeneity. The empirical analysis is conducted on data drawn from the 1967–1992 Panel Study of Income Dynamics. We find strong evidence of sizeable ARCH effects as well as evidence of unobserved heterogeneity in the variances.

/pdf/income-variance-dynamics-and-heterogeneity-10soet1gpb.pdf

Income Variance Dynamics and Heterogeneity

We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. We present evidence supporting three predictions of this model by analyzing bunching at kinks using Danish tax records. First, larger kinks generate larger taxable income elasticities. Second, kinks that apply to a larger group of workers generate larger elasticities. Third, the distribution of job offers is tailored to match workers' aggregate tax preferences in equilibrium. Our results suggest that macro elasticities may be substantially larger than the estimates obtained using standard microeconometric methods.

/pdf/adjustment-costs-firm-responses-and-micro-vs-macro-labor-2opc962ywd.pdf

Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records

We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. In this model, micro elasticities are smaller than macro elasticities because they do not account for adjustment costs and firm responses. We present evidence supporting three predictions of the model by analyzing bunching at kinks using the universe of tax records in Denmark. First, larger kinks generate larger taxable income elasticities because they are more likely to overcome search costs. Second, kinks that apply to a larger group of workers generate larger elasticities because they induce changes in hours constraints. Third, firms tailor job offers to match workers' aggregate tax preferences in equilibrium. Calibrating our model to match these empirical findings, we obtain a lower bound on the intensive-margin macro elasticity of 0.34, an order of magnitude larger than the estimates obtained using standard microeconometric methods for wage earners in our data.

Luigi Pistaferri

Papers

Consumption inequality and partial insurance

The Consumption Response to Income Changes

Income Variance Dynamics and Heterogeneity

Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records

Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records