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High Persistence and Nonlinear Behavior in Financial Variables: A More Powerful Unit Root Testing in the ESTAR Framework

Author

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  • Tolga Omay

    (Department of Economics, Atilim University, 06830 Ankara, Turkey)

  • Aysegul Corakci

    (Department of Economics, Çankaya University, 06790 Ankara, Turkey)

  • Esra Hasdemir

    (Department of Logistics Management, University of Turkish Aeronautical Association, 06790 Ankara, Turkey)

Abstract

In this study, we consider the hybrid nonlinear features of the Exponential Smooth Transition Autoregressive-Fractional Fourier Function (ESTAR-FFF) form unit root test. As is well known, when developing a unit root test for the ESTAR model, linearization is performed by the Taylor approximation, and thereby the nuisance parameter problem is eliminated. Although this linearization process leads to a certain amount of information loss in the unit root testing equation, it also causes the resulting test to be more accessible and consistent. The method that we propose here contributes to the literature in three important ways. First, it reduces the information loss that arises due to the Taylor expansion. Second, the research to date has tended to misinterpret the Fourier function used with the Kapetanios, Shin and Snell (2003) (KSS) unit root test and considers it to capture multiple smooth transition structural breaks. The simulation studies that we carry out in this study clearly show that the Fourier function only restores the Taylor residuals of the ESTAR type function rather than accounting forthe smooth structural break. Third, the new nonlinear unit root test developed in this paper has very strong power in the highly persistent near unit root environment that the financial data exhibit. The application of the Kapetanios Shin Snell- Fractional Fourier (KSS-FF) test to ex-post real interest rates data of 11 OECD countries for country-specific sample periods shows that the new test catches nonlinear stationarity in many more countries than the KSS test itself.

Suggested Citation

  • Tolga Omay & Aysegul Corakci & Esra Hasdemir, 2021. "High Persistence and Nonlinear Behavior in Financial Variables: A More Powerful Unit Root Testing in the ESTAR Framework," Mathematics, MDPI, vol. 9(20), pages 1-21, October.
    • Handle: RePEc:gam:jmathe:v:9:y:2021:i:20:p:2534-:d:652350
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    References listed on IDEAS

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