Testing for unit roots with stationary covariates
We derive the family of tests for a unit root with maximal power against a point alternative when an arbitrary number of stationary covariates are modeled with the potentially integrated series. We show that very large power gains are available when such covariates are available. We then derive tests which are simple to construct (involving the running of vector autoregressions) and achieve at a point the power envelopes derived under very general conditions. These tests have excellent properties in small samples. We also show that these are obvious and internally consistent tests to run when identifying structural VAR's using long run restrictions.
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