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Impact of Model Specification Decisions on Unit Root Tests

Year 2011, Volume: 3 Issue: 2, 22 - 33, 01.09.2011

Abstract

Performance of unit root tests depends on several specification decisions prior to their application, e.g., whether or not to include a deterministic trend. Since there is no standard procedure for making such decisions; therefore, the practitioners routinely make several arbitrary specification decisions. In Monte Carlo studies, the design of data generating process supports these decisions, but for real data, such specification decisions are often unjustifiable and sometimes incompatible with data. We argue that the problems posed by choice of initial specification are quite complex and the existing voluminous literature on this issue treats only certain superficial aspects of this choice. Outcomes of unit root tests are very sensitive to both choice and sequencing of these arbitrary specifications. This means that we can obtain results of our choice from unit root tests by varying these specifications.

References

  • Andreou, E. and A. Spanos (2003). Statistical Adequacy and the Testing of Trend versus Difference Stationarity. Econometric Reviews, 223, 217-237.
  • Ayat, L. and P. Burridge (2000). Unit root tests in the presence of uncertainty about the nonstochastic trend. Journal of Econometrics, 95, 71-96.
  • Banerjee, A., R. Lumsdaine and J. Stock (1992). Recursive and sequential tests of unit-root and the trend break hypotheses: theory and international evidence. Journal of Business Economics and Statistics, 10, 271-287.
  • Cavaliere, G. (2004). Unit Root Tests under Time-Varying Variances. Econometric Reviews, 23, 259-292.
  • Christiano, L. (1992). Searching for a break in GNP. Journal of Business Economics and Statistics, 10, 237-250.
  • Dickey, D. and W. Fuller (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American Statistical Association, 74, 427-431.
  • Dickey, D. and W. Fuller (1981). Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root. Econometrica, 49, 1057-1072.
  • Diebold, F. and A. Senhadji (1996). The Uncertain Root in Real GNP: Comment. American Economic Review, 86, 1291-1298.
  • Elder, J. and P. Kennedy (2001). Testing for Unit Roots: What Should Students Be Taught? Journal of Economic Education, 322, 137-46.
  • Elliott, G., T.J. Rothenberg and J.H. Stock (1996). Efficient Tests for an Autoregressive Unit Root. Econometrica, 64, 813-836.
  • Enders, W. (2004). Applied Econometric Time Series. United States: John Wiley & Sons.
  • Hacker, R. and A. Hatemi-J (2006). The Properties of Procedures Dealing with Uncertainty about Intercept and Deterministic Trend in Unit Root Testing. http://ideas.repec.org/ p/hhs/cesisp/0214.html (accessed August 13, 2011).
  • Hamilton, J. (1994). Time Series Analysis. Princeton, New Jersey: Princeton University Press.
  • Holden, D. and R. Perman (1994). Unit roots and cointegration for the economist. In Cointegration for the Applied Economist, ed. B.B. Rao. New York, 47-112.
  • Kilian, L. and L. Ohanian (2002). Unit Roots, Trend Breaks and Transitory Dynamics: A Macroeconomic Perspective. Macroeconomic Dynamics, 6, 614-631.
  • Kim, T., S. Leybourne and P. Newbold (2002). Unit root tests with a break in innovation variance. Journal of Econometrics, 109, 365-387.
  • Libanio, G. (2005). Unit roots in macroeconomic time series: theory, implications and evidence. Nova Economia Belo Horizonte, 15, 3145-3176
  • Loretan, M. and P. Phillips (1994). Testing covariance stationarity under moment condition failure with an application to common stock returns. Journal of Empirical Finance, 1, 211-248
  • Lumsdaine, R. and D. Papell (1997). Multiple trend breaks and the unit root hypothesis. Review of Economics and Statistics, 79, 212-218.
  • MacKinnon, J. (1991). Critical Values for Cointegration Tests. In Long-run Economic Relationships, Readings in Cointegration ed. R. Engle and C. Granger. Oxford University Press, 267-276.
  • Murray, C. and C. Nelson (2000). The uncertain trend in U.S. GDP. Journal of Monetary Economics, 46, 79-95.
  • Nelson, C.R. and H. Kang (1984). Pitfalls in the Use of Time as an Explanatory Variable in Regression. Journal of Business and Economic Statistics, 2 (1), 73-82.
  • Nelson, C.R. and C.I. Plossor (1982). Trends and random walks in macroeconomics time series: some evidence and implications. Journal of Monetary Economics, 10, 139-162.
  • Ng, S. and P. Perron (2001). Lag length selection and the construction of unit root tests with good size and power. Econometrica, 69, 1519-1554.
  • Pagan, A.R., G.W. Schwert (1990). Testing for covariance stationarity in stock market data. Economics letters, 33, 165-170.
  • Papell, D.H. and R. Prodan (2007). Restricted Structural Change and the Unit Root Hypothesis. Economic Inquiry, 45 (4), 834-853.
  • Perron, P. (1988). Trends and random walks in macroeconomic time series. Journal of Economic Dynamics and Control, 12 (12), 297-332.
  • Perron, P. (1989). The great crash, the oil price shock and the unit root hypothesis. Econometrica, 57, 1361-1401.
  • Perron, P. (1990). Testing for a unit root in a time series with a changing mean. Journal of Business and Economic Statistics, 8, 153-162
  • Perron, P. (2003). Comment on "Statistical Adequacy and the Testing of Trend Versus Difference Stationarity" by Andreou and Spanos. Econometric Reviews, 22 (3) 239-245.
  • Perron, P. (2006). Dealing with Structural Breaks. In Palgrave Handbook of Econometrics, ed. K. Patterson and T.C. Mills. Vol. 1: Econometric Theory, Palgrave Macmillan, 278- 352.
  • Rudebusch, G. (1993). The Uncertain Unit Root in Real GNP. The American Economic Review, 83, 264-272.
  • Said, S. and D. Dickey (1984). Testing for unit roots in autoregressive moving average models of unknown order. Biometrika, 71, 599-607.
  • Watson, M.W. (1999). Explaining the increased variability in long-term interest rates. Richmond Economic Quarterly, 85, 71-96.
  • Zivot, E. and D. Andrews (1992). Further evidence on the great crash, the oil price shock and the unit root hypothesis. Journal of Business and Economic Statistics, 10, 251-270.
Year 2011, Volume: 3 Issue: 2, 22 - 33, 01.09.2011

Abstract

References

  • Andreou, E. and A. Spanos (2003). Statistical Adequacy and the Testing of Trend versus Difference Stationarity. Econometric Reviews, 223, 217-237.
  • Ayat, L. and P. Burridge (2000). Unit root tests in the presence of uncertainty about the nonstochastic trend. Journal of Econometrics, 95, 71-96.
  • Banerjee, A., R. Lumsdaine and J. Stock (1992). Recursive and sequential tests of unit-root and the trend break hypotheses: theory and international evidence. Journal of Business Economics and Statistics, 10, 271-287.
  • Cavaliere, G. (2004). Unit Root Tests under Time-Varying Variances. Econometric Reviews, 23, 259-292.
  • Christiano, L. (1992). Searching for a break in GNP. Journal of Business Economics and Statistics, 10, 237-250.
  • Dickey, D. and W. Fuller (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American Statistical Association, 74, 427-431.
  • Dickey, D. and W. Fuller (1981). Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root. Econometrica, 49, 1057-1072.
  • Diebold, F. and A. Senhadji (1996). The Uncertain Root in Real GNP: Comment. American Economic Review, 86, 1291-1298.
  • Elder, J. and P. Kennedy (2001). Testing for Unit Roots: What Should Students Be Taught? Journal of Economic Education, 322, 137-46.
  • Elliott, G., T.J. Rothenberg and J.H. Stock (1996). Efficient Tests for an Autoregressive Unit Root. Econometrica, 64, 813-836.
  • Enders, W. (2004). Applied Econometric Time Series. United States: John Wiley & Sons.
  • Hacker, R. and A. Hatemi-J (2006). The Properties of Procedures Dealing with Uncertainty about Intercept and Deterministic Trend in Unit Root Testing. http://ideas.repec.org/ p/hhs/cesisp/0214.html (accessed August 13, 2011).
  • Hamilton, J. (1994). Time Series Analysis. Princeton, New Jersey: Princeton University Press.
  • Holden, D. and R. Perman (1994). Unit roots and cointegration for the economist. In Cointegration for the Applied Economist, ed. B.B. Rao. New York, 47-112.
  • Kilian, L. and L. Ohanian (2002). Unit Roots, Trend Breaks and Transitory Dynamics: A Macroeconomic Perspective. Macroeconomic Dynamics, 6, 614-631.
  • Kim, T., S. Leybourne and P. Newbold (2002). Unit root tests with a break in innovation variance. Journal of Econometrics, 109, 365-387.
  • Libanio, G. (2005). Unit roots in macroeconomic time series: theory, implications and evidence. Nova Economia Belo Horizonte, 15, 3145-3176
  • Loretan, M. and P. Phillips (1994). Testing covariance stationarity under moment condition failure with an application to common stock returns. Journal of Empirical Finance, 1, 211-248
  • Lumsdaine, R. and D. Papell (1997). Multiple trend breaks and the unit root hypothesis. Review of Economics and Statistics, 79, 212-218.
  • MacKinnon, J. (1991). Critical Values for Cointegration Tests. In Long-run Economic Relationships, Readings in Cointegration ed. R. Engle and C. Granger. Oxford University Press, 267-276.
  • Murray, C. and C. Nelson (2000). The uncertain trend in U.S. GDP. Journal of Monetary Economics, 46, 79-95.
  • Nelson, C.R. and H. Kang (1984). Pitfalls in the Use of Time as an Explanatory Variable in Regression. Journal of Business and Economic Statistics, 2 (1), 73-82.
  • Nelson, C.R. and C.I. Plossor (1982). Trends and random walks in macroeconomics time series: some evidence and implications. Journal of Monetary Economics, 10, 139-162.
  • Ng, S. and P. Perron (2001). Lag length selection and the construction of unit root tests with good size and power. Econometrica, 69, 1519-1554.
  • Pagan, A.R., G.W. Schwert (1990). Testing for covariance stationarity in stock market data. Economics letters, 33, 165-170.
  • Papell, D.H. and R. Prodan (2007). Restricted Structural Change and the Unit Root Hypothesis. Economic Inquiry, 45 (4), 834-853.
  • Perron, P. (1988). Trends and random walks in macroeconomic time series. Journal of Economic Dynamics and Control, 12 (12), 297-332.
  • Perron, P. (1989). The great crash, the oil price shock and the unit root hypothesis. Econometrica, 57, 1361-1401.
  • Perron, P. (1990). Testing for a unit root in a time series with a changing mean. Journal of Business and Economic Statistics, 8, 153-162
  • Perron, P. (2003). Comment on "Statistical Adequacy and the Testing of Trend Versus Difference Stationarity" by Andreou and Spanos. Econometric Reviews, 22 (3) 239-245.
  • Perron, P. (2006). Dealing with Structural Breaks. In Palgrave Handbook of Econometrics, ed. K. Patterson and T.C. Mills. Vol. 1: Econometric Theory, Palgrave Macmillan, 278- 352.
  • Rudebusch, G. (1993). The Uncertain Unit Root in Real GNP. The American Economic Review, 83, 264-272.
  • Said, S. and D. Dickey (1984). Testing for unit roots in autoregressive moving average models of unknown order. Biometrika, 71, 599-607.
  • Watson, M.W. (1999). Explaining the increased variability in long-term interest rates. Richmond Economic Quarterly, 85, 71-96.
  • Zivot, E. and D. Andrews (1992). Further evidence on the great crash, the oil price shock and the unit root hypothesis. Journal of Business and Economic Statistics, 10, 251-270.
There are 35 citations in total.

Details

Subjects Business Administration
Other ID JA97JZ48ND
Journal Section Articles
Authors

- Atiq-ur-rehman This is me

Publication Date September 1, 2011
Submission Date September 1, 2011
Published in Issue Year 2011 Volume: 3 Issue: 2

Cite

APA Atiq-ur-rehman, .-. (2011). Impact of Model Specification Decisions on Unit Root Tests. International Econometric Review, 3(2), 22-33.
AMA Atiq-ur-rehman. Impact of Model Specification Decisions on Unit Root Tests. IER. December 2011;3(2):22-33.
Chicago Atiq-ur-rehman, -. “Impact of Model Specification Decisions on Unit Root Tests”. International Econometric Review 3, no. 2 (December 2011): 22-33.
EndNote Atiq-ur-rehman - (December 1, 2011) Impact of Model Specification Decisions on Unit Root Tests. International Econometric Review 3 2 22–33.
IEEE .-. Atiq-ur-rehman, “Impact of Model Specification Decisions on Unit Root Tests”, IER, vol. 3, no. 2, pp. 22–33, 2011.
ISNAD Atiq-ur-rehman, -. “Impact of Model Specification Decisions on Unit Root Tests”. International Econometric Review 3/2 (December 2011), 22-33.
JAMA Atiq-ur-rehman -. Impact of Model Specification Decisions on Unit Root Tests. IER. 2011;3:22–33.
MLA Atiq-ur-rehman, -. “Impact of Model Specification Decisions on Unit Root Tests”. International Econometric Review, vol. 3, no. 2, 2011, pp. 22-33.
Vancouver Atiq-ur-rehman -. Impact of Model Specification Decisions on Unit Root Tests. IER. 2011;3(2):22-33.