Homogenous panel unit root tests under cross sectional dependence: Finite sample modifications and the wild bootstrap

We investigate the performance of some homogenous first and second generation panel unit root tests under alternative forms of cross sectional dependence. We formalize contemporaneous correlation through factor models, spatial autoregressive error models and combinations thereof. Our findings confirm that while the first generation test of Levin, Lin, and Chu (2002) suffers from substantial size biases in dependent panels, the pooled test procedure of Jönsson (2005) and Breitung and Das (2005) is robust in large samples. We propose modifications of the latter test with improved finite sample size properties while retaining (size adjusted) power features. We show that the wild bootstrap is a feasible and efficient means to immunize the considered homogenous panel unit root tests against cross sectional dependence. JEL Classification: C23, C12