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Speci fication Sensitivities in Right-Tailed Unit Root Testing for Financial Bubbles

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  • Shu-Ping Shi

    ()
    (Research School of Economics, The Australian National University)

  • Peter C.B. Phillips

    ()
    (Yale University, University of Auckland, University of Southampton & Singapore Management University)

  • Jun Yu

    ()
    (School of Economics, Singapore Management Unversity)

Abstract

Right-tailed unit root tests have proved promising for detecting exuberance in economic and financial activities. Like left-tailed tests, the limit theory and test performance are sensitive to the null hypothesis and the model specifi cation used in parameter estimation. This paper aims to provide some empirical guidelines for the practical implementation of right-tailed unit root tests, focussing on the sup ADF test of Phillips, Wu and Yu (2011), which implements a right-tailed ADF test repeatedly on a sequence of forward sample recursions. We analyze and compare the limit theory of the sup ADF test under different hypotheses and model speci cations. The size and power properties of the test under various scenarios are examined in simulations and some recommendations for empirical practice are given. An empirical application to Nasdaq data reveals the practical importance of model speci cation on test outcomes.

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Bibliographic Info

Paper provided by Singapore Management University, School of Economics in its series Working Papers with number 08-2011.

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Length: 29 pages
Date of creation: Aug 2011
Date of revision:
Publication status: Published in SMU Economics and Statistics Working Paper Series
Handle: RePEc:siu:wpaper:08-2011

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Keywords: Unit root test; Mildly explosive process; Recursive regression; Size and power;

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  1. Peter C. B. Phillips & Yangru Wu & Jun Yu, 2007. "Explosive Behavior in the 1990s Nasdaq: When Did Exuberance Escalate Asset Values?," Working Papers 222007, Hong Kong Institute for Monetary Research.
  2. Schmidt, Peter & Phillips, C B Peter, 1992. "LM Tests for a Unit Root in the Presence of Deterministic Trends," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 257-87, August.
  3. Peter C.B. Phillips, 1985. "Time Series Regression with a Unit Root," Cowles Foundation Discussion Papers 740R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1986.
  4. Peter C.B. Phillips & Tassos Magdalinos, 2004. "Limit Theory for Moderate Deviations from a Unit Root," Cowles Foundation Discussion Papers 1471, Cowles Foundation for Research in Economics, Yale University.
  5. Diba, Behzad T & Grossman, Herschel I, 1988. "Explosive Rational Bubbles in Stock Prices?," American Economic Review, American Economic Association, vol. 78(3), pages 520-30, June.
  6. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-30, September.
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Cited by:
  1. Yoon, Gawon, 2012. "Explosive U.S. budget deficit," Economic Modelling, Elsevier, vol. 29(4), pages 1076-1080.

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