Regression with a Slowly Varying Regressor in the Presence of a Unit Root
This paper considers the regression model with a slowly varying (SV) regressor in the presence of a unit root in serially correlated disturbances. This regressor is known to be asymptotically collinear with the constant term; see Phillips (2007). Under nonstationarity, we find that the estimated coefficients of the constant term and the SV regressor are asymptotically normal, but neither is consistent. Further, we derive the limiting distribution of the unit root test statistic. We may here observe that the finite sample approximation to the limiting one is not monotone and it is poor due to the influence of the collinear regressor. In order to construct a well-behaved test statistic, we recommend dropping the constant term intentionally from the regression and computing the statistics, which are still consistent under the true model having the constant term. The powers and sizes of these statistics are found to be well-behaved through simulation studies. Finally, these results are extended to general Phillips and Perron-type statistics.
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