A Panel Unit Root Test with Good Power in Small Samples

We propose a new pooled panel unit root test allowing for serial and contemporaneous correlation. The test combines Elliott et al. (1996) local-to-unity transformation with a pooled panel ADF test, and accounts for contemporaneous correlation by estimating the residual covariance matrix. The critical values are bootstrapped and Monte Carlo simulations demonstrate enhanced performances, especially when the series are highly persistent and the panel cross-sectional and time series dimensions are relatively small. An application of the test to the real exchange rate convergence for the post Bretton-Woods period leads to strong and reliable rejections of the unit root.