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Unit Roots, Trend Breaks and Transitory Dynamics: A Macroeconomic Perspective

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Author Info

  • Kilian, L.
  • Ohanian, L.E.

Abstract

There is a widespread tendency in the applied time series literature to interpret rejections of the unit root null hypothesis in favor of a trend stationary process with possible trend breaks as evidence that the data are better characterized as stationary about a broken trend. This interpretation is valid only if the model postulated under the alternative hypothesis is the only plausible alternative to the model postulated under the null. We argue that this implicit assumption is often questionable. There are economically plausible models that are not well captured either under the null hypothesis or under the alternative hypothesis of these tests. We show that applied researchers who ignore this possibility are likely to reject the unit root null with high probability in favor of a trend stationary process with possible breaks. The main contribution of this paper is to provide evidence that this potential pitfall is both economically relevant and quantitatively important. We also explore to what extent applied users may mitigate inferential errors by using finite-sample and bootstrap critical values.

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Bibliographic Info

Paper provided by Michigan - Center for Research on Economic & Social Theory in its series Papers with number 99-02.

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Length: 30 pages
Date of creation: 1999
Date of revision:
Handle: RePEc:fth:michet:99-02

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Postal: UNIVERSITY OF MICHIGAN, DEPARTMENT OF ECONOMICS CENTER FOR RESEARCH ON ECONOMIC AND SOCIAL THEORY, ANN ARBOR MICHIGAN U.S.A.

Related research

Keywords: TIME SERIES ; ECONOMIC MODELS ; UNIT ROOTS;

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Cited by:
  1. Yunus Aksoy & Miguel A. Leon-Ledesma, 2007. "Non-linearities and Unit Roots in G7 Macroeconomic Variables," Birkbeck Working Papers in Economics and Finance 0710, Birkbeck, Department of Economics, Mathematics & Statistics.
  2. Kejriwal, Mohitosh & Lopez, Claude, 2010. "Unit Roots, Level Shifts and Trend Breaks in Per Capita Output: A Robust Evaluation," MPRA Paper 25204, University Library of Munich, Germany.
  3. Robinson Kruse & Michael Frömmel & Lukas Menkhoff & Philipp Sibbertsen, 2012. "What do we know about real exchange rate nonlinearities?," Empirical Economics, Springer, vol. 43(2), pages 457-474, October.
  4. Atiq-ur-Rehman, Atiq-ur-Rehman & Zaman, Asad, 2008. "Model specification, observational equivalence and performance of unit root tests," MPRA Paper 13489, University Library of Munich, Germany.
  5. Darné, Olivier, 2009. "The uncertain unit root in real GNP: A re-examination," Journal of Macroeconomics, Elsevier, vol. 31(1), pages 153-166, March.
  6. Atiq-ur-Rehman, 2011. "Impact of Model Specification Decisions on Unit Root Tests," International Econometric Review (IER), Econometric Research Association, vol. 3(2), pages 22-33, September.
  7. Darne, Olivier & Diebolt, Claude, 2004. "Unit roots and infrequent large shocks: new international evidence on output," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1449-1465, October.
  8. Paraskevi Salamaliki & Ioannis Venetis & Nicholas Giannakopoulos, 2013. "The causal relationship between female labor supply and fertility in the USA: updated evidence via a time series multi-horizon approach," Journal of Population Economics, Springer, vol. 26(1), pages 109-145, January.
  9. Salamaliki, Paraskevi K. & Venetis, Ioannis A., 2013. "Energy consumption and real GDP in G-7: Multi-horizon causality testing in the presence of capital stock," Energy Economics, Elsevier, vol. 39(C), pages 108-121.

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