Joakim Westerlund

In an influential paper, Hansen (Rethinking the Univariate Approach to Unit Root
Testing: Using Covariates to Increase Power, Econometric Theory 11, 1148–1171, 1995)
shows that covariate augmentation can lead to substantial power gains when compared
to univariate tests. In this paper we ask if this result extends also to the panel data
context? The answer turns out to be yes, which is maybe not that surprising. What is
surprising, however, is the extent of the power gain, which is shown to be able to more
than outweigh the well-known power loss in the presence of incidental trends. That is,
the covariates have an order effect on the neighborhood around unity for which local
asymptotic power is negligible.