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Model specification, observational equivalence and performance of unit root tests

  • Atiq-ur-Rehman, Atiq-ur-Rehman
  • Zaman, Asad

In this paper we highlight the necessity of new criteria for evaluation of performance of unit root tests. We suggest focusing directly on the reasons that create ambiguity in unit root test’s results. Two reasons for unsatisfactory properties of unit root tests can be found in the literature (i) the model misspecification and (ii) observational equivalence. Regarding first reason, there is immense literature on several components of model specification covering specification techniques, consequence of misspecification and robust methods. However complete model specification involves multiple decisions and most of studies on performance of unit root tests do not address issue of multiple specification decisions simultaneously. The Monte Carlo studies are conditional on some of implicit specification and for Monte Carlo; these specifications are by construction valid. But for real data, the implicit decisions are often not true and specification decisions need to be endogenized. A closer match with real case is possible if multiple specification decisions are endogenized, thus providing more reliable measure of performance of unit root tests. Second problem in differentiating trend and difference stationary process is the observational equivalence between two processes. We suggest exploring data generating processes with different long run dynamics and small sample equivalence so that a researcher should have an idea about other plausible models for a data set for which he has estimated some model.

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File URL: http://mpra.ub.uni-muenchen.de/13489/1/MPRA_paper_13489.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13489.

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Date of creation: Jul 2008
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Handle: RePEc:pra:mprapa:13489
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  1. Rudebusch, Glenn D, 1993. "The Uncertain Unit Root in Real GNP," American Economic Review, American Economic Association, vol. 83(1), pages 264-72, March.
  2. Serena Ng & Pierre Perron, 1997. "Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power," Boston College Working Papers in Economics 369, Boston College Department of Economics, revised 01 Sep 2000.
  3. Giuseppe Cavaliere, 2005. "Unit Root Tests under Time-Varying Variances," Econometric Reviews, Taylor & Francis Journals, vol. 23(3), pages 259-292.
  4. Christiano, Lawrence J, 1992. "Searching for a Break in GNP," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 237-50, July.
  5. Charles Nelson & Christian Murray, 1997. "The Uncertain Trend in U.S. GDP," Computational Economics 9702001, EconWPA.
  6. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
  7. Mark W. Watson, 1999. "Explaining the increased variability in long-term interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 71-96.
  8. Eric Zivot & Donald W.K. Andrews, 1990. "Further Evidence on the Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Cowles Foundation Discussion Papers 944, Cowles Foundation for Research in Economics, Yale University.
  9. Campbell, J.Y. & Perron, P., 1991. "Pitfalls and Opportunities: What Macroeconomics should know about unit roots," Papers 360, Princeton, Department of Economics - Econometric Research Program.
  10. John Elder & Peter E. Kennedy, 2001. "Testing for Unit Roots: What Should Students Be Taught?," The Journal of Economic Education, Taylor & Francis Journals, vol. 32(2), pages 137-146, January.
  11. Kim, Tae-Hwan & Leybourne, Stephen & Newbold, Paul, 2002. "Unit root tests with a break in innovation variance," Journal of Econometrics, Elsevier, vol. 109(2), pages 365-387, August.
  12. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
  13. Kilian, L. & Ohanian, L.E., 1999. "Unit Roots, Trend Breaks and Transitory Dynamics: A Macroeconomic Perspective," Papers 99-02, Michigan - Center for Research on Economic & Social Theory.
  14. Nunes, Luis C. & Kuan, Chung-Ming & Newbold, Paul, 1995. "Spurious Break," Econometric Theory, Cambridge University Press, vol. 11(04), pages 736-749, August.
  15. Cati, Regina Celia & Garcia, Marcio G P & Perron, Pierre, 1999. "Unit Roots in the Presence of Abrupt Governmental Interventions with an Application to Brazilian Data," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(1), pages 27-56, Jan.-Feb..
  16. Diebold, Francis X & Senhadji, Abdelhak S, 1996. "The Uncertain Unit Root in Real GNP: Comment," American Economic Review, American Economic Association, vol. 86(5), pages 1291-98, December.
  17. Hacker, Scott & Hatemi-J, Abdulnasser, 2010. "The Properties of Procedures Dealing with Uncertainty about Intercept and Deterministic Trend in Unit Root Testing," Working Paper Series in Economics and Institutions of Innovation 214, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
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