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Nonlinear IV panel unit root testing under structural breaks in the error variance

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  • Matei Demetrescu
  • Christoph Hanck

Abstract

The paper examines the behavior of a generalized version of the nonlinear IV unit root test proposed by Chang ( 2002 ) when the series’ errors exhibit nonstationary volatility. The leading case of such nonstationary volatility concerns structural breaks in the error variance. We show that the generalized test is not robust to variance changes in general, and illustrate the extent of the resulting size distortions in finite samples. More importantly, we show that pivotality is recovered when using Eicker-White heteroskedasticity-consistent standard errors. This contrasts with the case of Dickey-Fuller unit root tests, for which Eicker-White standard errors do not produce robustness and thus require computationally costly corrections such as the (wild) bootstrap or estimation of the so-called variance profile. The pivotal versions of the generalized IV tests – with or without the correct standard errors – do however have no power in $$1/T$$ -neighbourhoods of the null. We also study the validity of panel versions of the tests considered here. Copyright Springer-Verlag Berlin Heidelberg 2013

Suggested Citation

  • Matei Demetrescu & Christoph Hanck, 2013. "Nonlinear IV panel unit root testing under structural breaks in the error variance," Statistical Papers, Springer, vol. 54(4), pages 1043-1066, November.
    • Handle: RePEc:spr:stpapr:v:54:y:2013:i:4:p:1043-1066
    DOI: 10.1007/s00362-013-0502-5
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    References listed on IDEAS

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