Modelling and Testing for Structural Breaks in Panels with Common and Idiosyncratic Stochastic Trends Chihwa Kao Syracuse University cdkao@maxwell.syr.edu Lorenzo Trapani Cass Business School and Bergamo University L.Trapani@city.ac.uk Giovanni Urga Cass Business School G.Urga@city.ac.uk January 14, 2005 Preliminary Abstract This paper studies testing for detecting a break at an unknown date in panel data with common stochastic and idiosyncratic trends. To model the common stochastic trends, we assume that the data is generated by common factors. We propose tests and derive their limiting distributions under the null of no change point. We derive the limiting distribution and the proposed test and tabulate the critical values. Monte Carlo sim- ulations are performed to examine the size and power of the proposed tests. KEY WORDS: Panel cointegration, common and idiosyncratic stochas- tic Trends, structural breaks. 1 Introduction This paper develops an asymptotic theory of inference for panel cointegration models with common and idiosyncratic trends. Then we propose test statistics for structural break using the developed asymptotic theory. As is well known in the time series literature, structural breaks can have a significant impact on the testing and estimating of cointegrated relationships. Thus, the diagnosing and testing of structural breaks can become critical. However, the literature 1