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This paper proposes the use of an improved covariate unit root test which exploits the cross‐sectional dependence information when the panel data null hypothesis of a unit root is rejected. More explicitly, to increase the power of the test, we suggest the utilization of more than one covariate and offer several ways to select the 'best' covariates from the set of potential covariates represented by the individuals in the panel. Employing our methods, we investigate the Prebish‐Singer hypothesis for nine commodity prices. Our results show that this hypothesis holds for all but the price of petroleum.

ABSTRACTConventional unit root tests are biased towards non‐rejection of the null when applied to variables characterized by a one‐time change in their mean. Suggested modifications allowing for a break point require identification of an exogenous change initiated at the time of the break and not subsequently reversed. This paper suggests that modified tests are particularly useful in dealing with legislative changes. Two UK examples are given; the abolition of exchange controls in 1979 and the changes in monetary policy in 1980. Results suggest that allowing for a break changes the apparent order of integration of portfolio shares and real interest rates.

AbstractThis paper re‐examines the empirical finding that international real interest rates usually have a unit root. This conclusion is put forth in Rapach and Weber (2004), using the Ng and Perron (2001) tests. We use Rudebusch's (1993) approach to construct the small sample distributions of the Ng and Perron tests, and calculate their asymptotic sizes, size‐adjusted powers and rejection rates. These numbers show that the lack of power in the Ng and Perron tests might account for the findings of Rapach and Weber (2004): that the unit root null cannot be rejected for most OECD countries. Size distortions are mild in the case of Ng and Perron tests for two series, but are serious for the Phillips and Perron Z‐test on inflation rates. We then apply a powerful covariate augmented Dickey–Fuller unit root test to examine the series for which stationarity cannot be determined with the Ng and Perron tests. The bootstrap technique is also used to control possible size distortions. In contrast to the results of Rapach and Weber (2004), the bootstrap covariate augmented Dickey–Fuller test yields striking evidence that real interest rates are stationary for 14 of 16 OECD countries, because nominal interest rates are stationary for the 14 countries, while inflation rates are stationary for all countries.