CIPS Test — Cross-sectionally Augmented IPS Panel Unit-Root Test
Cross-sectionally Augmented IPS (CIPS) Panel Unit-Root Test · Also known as: Pesaran CIPS Test, Cross-Sectionally Augmented IPS, Second-Generation Panel Unit-Root Test, CIPS Birim Kök Testi
The CIPS test, introduced by Pesaran (2007), is a second-generation panel unit-root test designed for panels in which the cross-sectional units share unobserved common factors that induce cross-section dependence. By augmenting each individual ADF regression with cross-sectional averages and their lags, the CIPS test accounts for this dependence and produces reliable inference where first-generation tests such as the original IPS test break down. It is widely applied in macroeconomic and finance panels where shocks propagate across countries or regions.
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When to use it
Use the CIPS test when you have a balanced or nearly balanced panel and prior evidence or theory suggests cross-section dependence — for instance, panels of countries, regions, or firms exposed to common macroeconomic shocks. The test assumes a single-factor structure for the error cross-section dependence and works best when T is moderate to large relative to N. It should not replace, but rather complement, diagnostic tests for cross-section dependence (e.g., Pesaran's CD test). If multiple common factors are suspected, the PANIC approach may be preferable.
Strengths & limitations
- Explicitly accounts for cross-section dependence through cross-sectional augmentation, correcting the severe size distortions of first-generation tests such as LLC or IPS under dependence.
- Computationally simple: requires only OLS estimation of N augmented ADF regressions followed by averaging, with no need to estimate factor models directly.
- Valid under both stationary and non-stationary common factors, making it robust to a wide range of data-generating processes.
- Tabulated critical values covering a wide grid of (N, T) combinations are provided by Pesaran (2007), facilitating straightforward inference.
- The single-factor cross-section dependence assumption may be violated in panels driven by multiple common shocks, reducing test accuracy.
- Critical values are tabulated for specific (N, T) combinations; interpolation is required for non-tabulated panel dimensions.
- The test has low power when only a small fraction of units are stationary (the alternative hypothesis is heterogeneous), though this is common to all IPS-type tests.
- Requires a balanced or near-balanced panel; large proportions of missing observations complicate the computation of cross-sectional averages.
Frequently asked
How does the CIPS test differ from the original IPS test?
The IPS test averages individual ADF t-statistics from regressions that contain only unit-specific regressors, making it invalid under cross-section dependence. The CIPS test augments each individual ADF regression with cross-sectional averages and their lags to proxy for common factors, restoring size control under dependence while retaining the simple averaging structure of IPS.
Do I need to estimate a factor model before running the CIPS test?
No. That is the key practical advantage of the CIPS approach. The cross-sectional mean of the observed panel series acts as a proxy for the latent common factor, so no separate factor extraction step (such as principal components) is required. You only need to run N augmented ADF regressions by OLS and then average the resulting t-statistics.
What should I do if the CIPS test and a first-generation test give conflicting results?
When a CD test or similar diagnostic confirms cross-section dependence, you should trust the CIPS result over the first-generation test, because the latter is known to be oversized under dependence. If cross-section dependence is absent, both tests should agree asymptotically; any discrepancy is likely a finite-sample artifact that may warrant checking lag selection and deterministic specification.
Sources
- Pesaran, M. H. (2007). A simple panel unit root test in the presence of cross-section dependence. Journal of Applied Econometrics, 22(2), 265–312. DOI: 10.1002/jae.951 ↗
How to cite this page
ScholarGate. (2026, June 2). Cross-sectionally Augmented IPS (CIPS) Panel Unit-Root Test. ScholarGate. https://scholargate.app/en/econometrics/cips-test
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