The local power of some unit root tests for panel data

To test the hypothesis of a difference stationary time series against a trend stationary alternative, Levin & Lin (1993) and Im, Pesaran & Shin (1997) suggest bias adjusted t-statistics. Such corrections are necessary to account for the nonzero mean of the t-statistic in the case of an OLS detrending method. In this chapter the local power of panel unit root statistics against a sequence of local alternatives is studied. It is shown that the local power of the test statistics is affected by two different terms. The first term represents the asymptotic effect on the bias due to the detrending method and the second term is the usual location parameter of the limiting distribution under the sequence of local alternatives. It is argued that both terms can offset each other so that the test has no power against the sequence of local alternatives. These results suggest to construct test statistics based on alternative detrending methods. We consider a class of t-statistics that do not require a bias correction. The results of a Monte Carlo experiment suggest that avoiding the bias can improve the power of the test substantially.