Spurious Trend and Cycle in the State Space Decomposition of a Time Series with a Unit Root
AbstractRecent research has proposed the state space (88) framework for decomposition of GNP and other economic time series into trend and cycle components, using the Kalman filter. This paper reviews the empirical evidence and suggests that the resulting decomposition may be spurious, just as detrending by linear regression is known to generate spurious trends and cycles in nonstationary time series. A Monte Carlo experiment confirms that when data is generated by a random walk, the 88 model tends to indicate (incorrectly) that the series consists of cyclical variations around a smooth trend. The improvement in fit over the true model will typically appear to be statistically significant. These results suggest that caution should be exercised in drawing inferences about the nature of economic processes from the 88 decomposition.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0063.
Date of creation: Nov 1987
Date of revision:
Publication status: published as Journal of Economic Dynamics and Control, vol. 12,no.2/3, June/September 1988, pp475-488.
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Other versions of this item:
- Nelson, Charles R., 1988. "Spurious trend and cycle in the state space decomposition of a time series with a unit root," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 475-488.
- NEP-ALL-2001-09-10 (All new papers)
- NEP-ECM-2001-09-10 (Econometrics)
- NEP-ETS-2001-09-10 (Econometric Time Series)
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