Showing papers in "Journal of Applied Econometrics in 2007"

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

Abstract: 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.

Exploring the international linkages of the euro area: a global VAR analysis

Abstract: This paper presents a global model linking individual country vector error-correcting models in which the domestic variables are related to the country-specific variables as an approximate solution to a global common factor model. This global VAR is estimated for 26 countries, the euro area being treated as a single economy. This paper proposes two important extensions of previous research (see Pesaran, Schuermann and Weiner, 2004). First, it provides a theoretical framework where the GVAR is derived as an approximation to a global unobserved common factor model. Also using average pair-wise cross-section error correlations, the GVAR approach is shown to be quite effective in dealing with the common factor interdependencies and international comovements of business cycles. Second, in addition to generalised impulse response functions, we propose an identification scheme to derive structural impulse responses. We focus on identification of shocks to the US economy, particularly the monetary policy shocks, and consider the time profiles of their effects on the euro area. To this end we include the US model as the first country model and consider alternative orderings of the US variables. Further to the US monetary policy shock, we also consider oil price, US equity and US real output shocks.

Growth, Technological Interdependence and Spatial Externalities - Theory and Evidence

Abstract: SUMMARY This paper presents a theoretical growth model which explicitly takes into account technological interdependence among economies and examines the impact of spillover effects. Technological interdependence is assumed to operate through spatial externalities. The magnitude of the physical capital externalities at steady state, which is not usually identified in the literature, is estimated using a spatial econometric specification. Spatial externalities are found to be significant. This spatially augmented Solow model yields a conditional convergence equation which is characterized by parameter heterogeneity. A locally linear spatial autoregressive specification is then estimated providing a convergence speed estimate for each country of the sample. Copyright  2007 John Wiley & Sons, Ltd.

The relationship between R&D collaboration, subsidies and R&D performance: Empirical evidence from Finland and Germany

Abstract: This study focuses on the impact of innovation policies and R&D collaboration in Germany and Finland. We consider collaboration and subsidies as heterogeneous treatments, and perform an econometric matching to analyze R&D and patent activity at the firm level. In general, we find that collaboration has positive effects. In Germany, subsidies for individual research do neither exhibit a significant impact on R&D nor on patenting, but the innovative performance could be improved by additional incentives for collaboration. For Finnish companies, public funding is an important source of finance for R&D. Without subsidies, recipients would show less R&D and patenting activity, whilst those firms not receiving subsidies would perform significantly better if they were publicly funded. Copyright © 2007 John Wiley & Sons, Ltd.

On the effect of prior assumptions in Bayesian model averaging with applications to growth regression

Abstract: This paper examines the problem of variable selection in linear regression models. Bayesian model averaging has become an important tool in empirical settings with large numbers of potential regressors and relatively limited numbers of observations. The paper analyzes the effect of a variety of prior assumptions on the inference concerning model size, posterior inclusion probabilities of regressors, and predictive performance. The analysis illustrates these issues in the context of cross-country growth regressions using three datasets with 41 to 67 potential drivers of growth and 72 to 93 observations. The results favor particular prior structures for use in this and related contexts.

The interrelated dynamics of unemployment and low-wage employment

Abstract: This paper examines the extent of state dependence in unemployment and the role played in this by intervening low-wage employment. A range of dynamic random and fixed effects estimators are compared. Low-wage employment is found to have almost as large an adverse effect as unemployment on future prospects and the difference in their effects is found to be insignificant. Evidence is presented that low-wage jobs act as the main conduit for repeat unemployment and considerably increases its probability. Obtaining a higher-wage job reduces the increased risk of repeat unemployment to insignificance.

Jumps, cojumps and macro announcements

Abstract: We use recently proposed tests to extract jumps and cojumps from three types of assets: stock index futures, bond futures, and exchange rates. We then characterize the dynamics of these discontinuities and informally relate them to US macroeconomic releases before using limited dependent variable models to formally model how news surprises explain (co)jumps. Nonfarm payroll and federal funds target announcements are the most important news across asset classes. Trade balance shocks are important for foreign exchange jumps. We relate the size, frequency and timing of jumps across asset classes to the likely sources of shocks and the relation of asset prices to fundamentals in the respective classes.

Unravelling financial market linkages during crises

Abstract: An empirical model of multiple asset classes across countries is formulated in a latent factor framework. A special feature of the model is that financial market linkages during periods of financial crises, including spillover and contagion effects, are formally specified. The model also captures a range of common factors including global shocks, country and market shocks, and idiosyncratic shocks. The framework is applied to modelling linkages between currency and equity markets during the East Asian financial crisis of 1997-98. The results provide strong evidence that cross-market links are important. Spillovers have a relatively larger effect on volatility than contagion, but both are statistically significant.

Concessions of infrastructure in Latin America: Government‐led renegotiation

Abstract: This paper analyzes government-led renegotiations in infrastructure concession contracts in Latin America, based on the same sample used in Guasch, Laffont and Straub (2003) to examine firm-led renegotiations. After extending the theoretical framework to a multiple-period context in which both Pareto-improving and rent-shifting renegotiations at the initiative of the government can occur, we develop an original instrumental variable strategy to address the issue of contract endogeneity and derive empirical results. While some of the main insights concerning the importance of having a regulator in place when awarding concessions and the fragility of price cap regulatory schemes are unchanged, significant differences arise with respect to the effect of investment and financing, as well as the corruption variables. We provide evidence that a good regulatory framework is especially important in contexts with weak governance and political opportunism. Copyright © 2007 John Wiley & Sons, Ltd.

Gravity models of intra‐EU trade: application of the CCEP‐HT estimation in heterogeneous panels with unobserved common time‐specific factors

Abstract: We follow recent developments of panel data studies and allow for the existence of both observed and unobserved common factors where their individual responses are allowed to be heterogeneous. We then develop a generalized Hausman–Taylor estimation methodology, and apply our proposed estimation technique to an analysis of the gravity equation of bilateral trade flows among 15 European countries over 1960–2001. Empirical results demonstrate that our proposed approach provides more sensible results than the conventional approach based on fixed time dummies. These findings may highlight the importance of allowing for a certain degree of cross-section dependence through unobserved heterogeneous time-specific effects; the resulting estimates would otherwise be severely biased. Copyright © 2007 John Wiley & Sons, Ltd.

Panel unit root tests and spatial dependence

Abstract: This paper studies the performance of panel unit root tests when spatial effects are present that account for cross-section correlation. Monte Carlo simulations show that there can be considerable size distortions in panel unit root tests when the true specification exhibits spatial error correlation. These tests are applied to a panel data set on net real income from the 1000 largest French communes observed over the period 1985–1998. Copyright © 2007 John Wiley & Sons, Ltd.

Heterogeneity and cross section dependence in panel data models: Theory and applications introduction

Abstract: SUMMARY The papers included in this special issue are primarily concerned with the problem of cross section dependence and heterogeneity in the analysis of panel data models and their relevance in applied econometric research. Cross section dependence can arise due to spatial or spill over effects, or could be due to unobserved (or unobservable) common factors. Much of the recent research on non-stationary panel data have focussed on this problem. It was clear that the first generation panel unit root and cointegration tests developed in the 1990’s, which assumed cross-sectional independence, are inadequate and could lead to significant size distortions in the presence of neglected cross-section dependence. Second generation panel unit root and cointegration tests that take account of possible cross-section dependence in the data have been developed, see the recent surveys by Choi (2006) and Breitung and Pesaran (2007). The papers by Baltagi, Bresson and Pirotte, Choi and Chue, Kapetanios, and Pesaran in this special issue are further contributions to this literature. The papers by Fachin, and Moon and Perron are empirical studies in this area. Controlling for heterogeneity has also been an important concern for empirical researchers with panel data methods promising better handle on heterogeneity than cross-section data methods. The papers by Hsiao, Shen, Wang and Weeks, Pedroni and Serlenga and Shin are empirical contributions to this area. Copyright  2007 John Wiley & Sons, Ltd. 1. THEORETICAL CONTRIBUTIONS Choi and Chue study subsampling hypothesis tests for panel data that may be nonstationary, cross-sectionally correlated, and cross-sectionally cointegrated. The subsampling approach to hypothesis testing allows the regressors to be stationary or nonstationary with unit roots, or they may be a mixture of both types. It also allows for cross-sectional correlation that need not be estimated. This implies that there is less chance of size distortions due to misspecification, say from procedures assuming factor structures. Cross-sectional cointegration is also allowed without requiring knowledge of the cointegration coefficients and ranks. The subsampling approach provides approximations to the finite sample distributions of the tests without estimating nuisance parameters. The tests include panel unit root and cointegration tests as special cases. The number of cross-sectional units is assumed to be finite and that of time-series observations infinite. It is shown that subsampling provides asymptotic distributions that are equivalent to the asymptotic distributions of the panel tests. In addition, the tests using critical values from subsampling are shown to be consistent. 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.

Social capital, barriers to production and capital shares: implications for the importance of parameter heterogeneity from a nonstationary panel approach

Abstract: Recent advances in the growth literature have proposed that difficult-to-quantify concepts such as social capital may play an important role in explaining the degree of persistent income disparity that is observed among countries. Other recently explored possibilities include institutional mechanisms which generate barriers to aggregate production. An important limitation for empirical work in this area stems from the fact that it is difficult to distinguish sources of heterogeneity when direct observations are not available. In this study, we show how developments in the analysis of nonstationary panels can aid in this endeavor. In contrast to traditional dynamic panel data analysis, this approach focuses explicitly on low-frequency behavior. Under relatively mild assumptions, the approach can be used to infer properties of aggregate production which are robust to the presence of large classes of unobserved features. In this framework we are able to estimate and test the distribution of production function parameters that would be required in order to generate conditional forecast convergence of per capita incomes even when some of the key factors required to explain growth are unobserved. The results indicate that in order to fully explain the observed persistence in the disparity of per capita incomes, the manner in which unobserved mechanisms influence production must go beyond merely accounting for differences in the trending behavior of aggregate productivity. Specifically, if such mechanisms are to be successful empirically, they must also be able to account for cross-country heterogeneity in steady-state capital shares. This adds to a growing literature that provides support for models with multiple production regimes. Copyright © 2007 John Wiley & Sons, Ltd.

Estimating market power in a two-sided market: The case of newspapers

Abstract: The newspaper industry is a two-sided market: the readers market and the advertising market are closely linked by inter-market network externalities. We estimate market power in the Italian newspaper industry by building a structural model which encompasses a demand estimation

Identification of parameters in normal error component logit‐mixture (NECLM) models

Abstract: Although the basic structure of logit-mixture models is well understood, important identification and normalization issues often get overlooked. This paper addresses issues related to the identification of parameters in logit-mixture models containing normally distributed error components associated with alternatives or nests of alternatives (normal error component logit mixture, or NECLM, models). NECLM models include special cases such as unrestricted, fixed covariance matrices; alternative-specific variances; nesting and cross-nesting structures; and some applications to panel data. A general framework is presented for determining which parameters are identified as well as what normalization to impose when specifying NECLM models. It is generally necessary to specify and estimate NECLM models at the levels, or structural, form. This precludes working with utility differences, which would otherwise greatly simplify the identification and normalization process. Our results show that identification is not always intuitive; for example, normalization issues present in logit-mixture models are not present in analogous probit models. To identify and properly normalize the NECLM, we introduce the ‘equality condition’, an addition to the standard order and rank conditions. The identifying conditions are worked through for a number of special cases, and our findings are demonstrated with empirical examples using both synthetic and real data. Copyright © 2007 John Wiley & Sons, Ltd.

A discrete-choice model with social interactions: with an application to high school teen behavior

Abstract: We develop an empirical discrete-choice interaction model with a finite number of agents. We characterize its equilibrium properties-in particular the correspondence between interaction strength, number of agents, and the set of equilibria-and propose to estimate the model by means of simulation methods. In an empirical application, we analyze the individual behavior of high school teenagers in almost 500 school classes from 70 schools. In our baseline model endogenous social interaction effects are strong for behavior closely related to school (truancy), somewhat weaker for behavior partly related to school (smoking, cell phone ownership, and moped ownership) and absent for behavior far away from school (asking parents' permission for purchases). Intra-gender interactions are generally much stronger than cross-gender interactions. In a model with school-specific fixed effects social interaction effects are insignificant, with the exception of intra-gender interactions for truancy. Copyright (c) 2007 John Wiley & Sons, Ltd.

Quantifying the supply-side benefits from forward contracting in wholesale electricity markets

Abstract: SUMMARY The assumption of expected profit-maximizing bidding behavior in a multi-unit, multi-period auction with step-function supply curves is used to estimate cost functions for electricity generation units and derive tests of expected profit-maximizing behavior. Applying these techniques to data from the National Electricity Market in Australia reveals statistically significant evidence of output-dependent marginal costs within and across half-hours of the day, but no evidence against the hypothesis of expected profit-maximizing behavior. These cost function estimates quantify the economic significance of output-varying costs and how forward financial contract obligations impact the amount of these costs the generation unit owner incurs. This supplier’s existing obligations imply average daily production costs that are 8% lower than the profit-maximizing pattern of output with no forward contract obligations. Copyright  2007 John Wiley & Sons, Ltd.

Asymmetric power distribution: Theory and applications to risk measurement

Abstract: SUMMARY Theoretical literature in finance has shown that the risk of financial time series can be well quantified by their expected shortfall, also known as the tail value-at-risk. In this paper, I construct a parametric estimator for the expected shortfall based on a flexible family of densities, called the asymmetric power distribution (APD). The APD family extends the generalized power distribution to cases where the data exhibits asymmetry. The first contribution of the paper is to provide a detailed description of the properties of an APD random variable, such as its quantiles and expected shortfall. The second contribution of the paper is to derive the asymptotic distribution of the APD maximum likelihood estimator (MLE) and construct a consistent estimator for its asymptotic covariance matrix. The latter is based on the APD score whose analytic expression is also provided. A small Monte Carlo experiment examines the small sample properties of the MLE and the empirical coverage of its confidence intervals. An empirical application to four daily financial market series reveals that returns tend to be asymmetric, with innovations which cannot be modeled by either Laplace (double-exponential) or Gaussian distribution, even if we allow the latter to be asymmetric. In an out-ofsample exercise, I compare the performances of the expected shortfall forecasts based on the APD-GARCH, Skew-t-GARCH and GPD-EGARCH models. While the GPD-EGARCH 1% expected shortfall forecasts seem to outperform the competitors, all three models perform equally well at forecasting the 5% and 10% expected shortfall. Copyright  2007 John Wiley & Sons, Ltd.

Statistical inference for aggregates of Farrell-type efficiencies

Abstract: In this study, we merge results of two recent directions in efficiency analysis research-aggregation and bootstrap-applied, as an example, to one of the most popular point estimators of individual efficiency: the data envelopment analysis (DEA) estimator. A natural context of the methodology developed here is a study of efficiency of a particular economic system (e.g., an industry) as a whole, or a comparison of efficiencies of distinct groups within such a system (e.g., regulated vs. non-regulated firms or private vs. public firms). Our methodology is justified by the (neoclassical) economic theory and is supported by carefully adapted statistical methods. Copyright 2007 John Wiley & Sons, Ltd.

Nonparametric estimation of a hedonic price function

Abstract: In this paper we attempt to replicate the results of an article (Anglin and Gencay 1996) published in this journal which applied semiparametric procedures to estimate a hedonic price function. To relax additional restrictive assumptions, we also employ a fully nonparametric model that captures nonlinearity in both continuous and categorical variables. We find that the nonparametric procedure gives more intuitive and meaningful results.

Discounting the distant future: How much does model selection affect the certainty equivalent rate?

Abstract: Evaluating investment with long-term consequences using discount rates that decline with the time horizon. (Declining Discount Rates of DDRs) means that future welfare changes are of greater consequence in present value terms. Recent work in this area has turned towards operationalising the theory and establishing a schedule of DDRs for use in cost benefit analysis. Using US data we make the following points concerning this transition: i) model selectionhas important implications for operationalising a theory of DDRs that depends upon uncertainty; ii) misspecification testing naturally leads to employing models that account for changes in the interest reat generating medanism. Lastly, we provide an analysis of the policy implications of DDRs in the context of climate change for the US and show that the use of a state space model can increase valuations by 150% compared to conventional constant discounting.

Long-run trends in internal migrations in italy: a study in panel cointegration with dependent units

Abstract: The objective of this paper is to examine the long-run determinants of internal migrations from southern Italy. In order to accomplish this task, the paper develops a bootstrap test for panel cointegration analysis with dependent units. Monte Carlo simulations show that the test, based on the Continuous-Path Block bootstrap, has good power and size properties and is robust to both short- and long-run dependence across units. The empirical analysis points to income in the sending region as a key factor of the decline of migrations, with unemployment and income differentials playing only a minor role. Copyright © 2007 John Wiley & Sons, Ltd.

Sectoral adjustment of employment to shifts in outsourcing and trade: evidence from a dynamic fixed effects multinomial logit model

Abstract: This paper analyzes the efiects of trade and outsourcing on the transition probabilities of employment between sectors, using a dynamic multinomial logit framework with flxed efiects. The data cover a sample of individual Austrian male workers over the period 1988-2001. Our results strongly support the view that international economic forces are important determinants of labor market turnover. Especially, an increase in the outsourcing intensity negatively afiects the probability of staying in or changing into the manufacturing sector, even more so for industries with a comparative disadvantage.

Habits and heterogeneity in demands: a panel data analysis

Abstract: We examine demand behaviour for intertemporal dependencies, using Spanishpanel data. We present evidence that there is both state dependence and correlatedheterogeneity in demand behaviour. Our specific findings are that food outside thehome, alcohol and tobacco are habit forming whereas clothing and small durablesexhibit durability. We conclude that demand analyses using cross-section data thatignore these effects may be seriously biased. On the other hand, the degree ofintertemporal dependence is not sufficiently strong to make composite `consumption'significantly habit forming, as has been suggested in some recent analyses.

An Evaluation of the Forecasts of the Federal Reserve: A Pooled Approach

Abstract: The Federal Reserve Greenbook forecasts of real GDP, inflation and unemployment are analysed for the period 1974 to 1997. We consider whether these forecasts exhibit systematic bias, and whether efficient use is made of information, that is, whether revisions to these forecasts over time are predictable. Rather than analyse the forecasts separately for each horizon of interest, we discuss and implement methods that pool information over horizons. We conclude that there is evidence of systematic bias and of forecast smoothing of the inflation forecasts.

Robust Optimal Policy in a Forward-Looking Model with Parameter and Shock Uncertainty

Abstract: This paper characterizes a robust optimal policy rule in a simple forward-looking model, when the policymaker faces uncertainty about model parameters and shock processes. We show that the robust optimal policy rule is likely to involve a stronger response of the interest rate to fluctuations in inflation and the output gap than is the case in the absence of uncertainty. Thus parameter uncertainty alone does not necessarily justify a small response of monetary policy to perturbations. However, uncertainty may amplify the degree of ‘super-inertia’ required by optimal monetary policy. We finally discuss the sensitivity of the results to alternative assumptions. Copyright © 2007 John Wiley & Sons, Ltd.

Small‐sample bias in synthetic cohort models of labor supply

Abstract: This paper investigates small-sample biases in synthetic cohort models (repeated cross-sectional data grouped at the cohort and year level) in the context of a female labor supply model. I use the Current Population Survey to compare estimates when group sizes are extremely large to those that arise from randomly drawing subsamples of observations from the large groups. I augment this approach with Monte Carlo analysis so as to precisely quantify biases and coverage rates. In this particular application, thousands of observations per group are required before small-sample issues can be ignored in estimation and sampling error leads to large downward biases in the estimated income elasticity. Copyright © 2007 John Wiley & Sons, Ltd.

The transmission mechanism in a changing world

Abstract: This Paper aims at improving the understanding of the transmission of shocks across countries and how this transmission may have changed over time. By employing a model that allows for parameter changes across regimes, we show that transmission of shocks from the US to European countries may depend on the values of transition variables such as financial prices, exchange rates, international capital flows, trade links and monetary policy instruments. We also show that transmission mechanisms estimated with the proposed models have good performance in describing the 2001 downturn in some European countries as an effect of a US shock. More generally, the models have a good forecasting performance over short horizons.

Medical Expenditure Risk and Household Portfolio Choice

Abstract: Medical expenses are an increasingly important contributor to household financial risk. We examine the effect of medical expenditure risk on the willingness of Medicare beneficiaries to hold risky assets. Using a discrete factor maximum likelihood method to address the endogeneity of insurance choices, we find that having a moderately protective Medigap or employer supplemental policy increases risky asset holding by 7.1 percentage points relative to those without supplemental coverage, while participation in a highly protective Medicare HMO increases risky asset holding by 13.0 percentage points. Our results highlight an important link between the availability of health insurance and financial behavior.

Subsampling hypothesis tests for nonstationary panels with applications to exchange rates and stock prices

Abstract: This paper studies subsampling hypothesis tests for panel data that may be nonstationary, cross-sectionally correlated, and cross-sectionally cointegrated. The subsampling approach provides approximations to the finite sample distributions of the tests without estimating nuisance parameters. The tests include panel unit root and cointegration tests as special cases. The number of cross-sectional units is assumed to be finite and that of time-series observations infinite. It is shown that subsampling provides asymptotic distributions that are equivalent to the asymptotic distributions of the panel tests. In addition, the tests using critical values from subsampling are shown to be consistent. The subsampling methods are applied to panel unit root tests. The panel unit root tests considered are Levin, Lin, and Chu's (2002) t-test; Im, Pesaran, and Shin's (2003) averaged t-test; and Choi's (2001) inverse normal test. Simulation results regarding the subsampling panel unit root tests and some existing unit root tests for cross-sectionally correlated panels are reported. In using the subsampling approach to examine the real exchange rates of the G7 countries and a group of 26 OECD countries, we find only mixed support for the purchasing power parity (PPP) hypothesis. We then examine a panel of 17 developed stock market indexes, and also find only mixed empirical support for them exhibiting relative mean reversion with respect to the US stock market index. Copyright © 2007 John Wiley & Sons, Ltd.