Markov Regime Switching and Unit-Root Tests

Charles R. Nelson · Jeremy Max Piger · Eric W. Zivot

134 citations0/0 files storedJournal of Business and Economic Statistics

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Monetary Policy and Economic Impact Financial Risk and Volatility Modeling Diverse Scientific and Economic Studies

Abstract

We investigate the power and size performance of unit-root tests when the data undergo Markov regime switching. All tests, including those robust to a single break in trend growth rate, have low power against a process with a Markov-switching trend. Under the null hypothesis, we find that previously documented size distortions in Dickey–Fuller-type tests caused by a single break in trend growth rate or variance do not generalize to most parameterizations of Markov switching in trend or variance. However, Markov switching in variance can lead to overrejection in tests allowing for a single break the level of trend.

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References

1979Distribution of the Estimators for Autoregressive Time Series with a Unit Root 1989A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle 1989The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis 2002Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis 1982Trends and random walks in macroeconmic time series 1984Testing for Unit Roots in Autoregressive-Moving Average Models of Unknown Order 1997Further evidence on breaking trend functions in macroeconomic variables 1992Further Evidence on the Great Crash, the Oil-Price Shock, and the Unit-Root Hypothesis

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