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Size distortions of tests of the null hypothesis of stationarity: Evidence and implications for applied work

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  • Caner, Mehmet
  • Kilian, Lutz

Abstract

It is common in applied econometrics to test the null hypothesis of a level-stationary process against the alternative of a unit root process. We show that the use of conventional asymptotic critical values for the stationarity tests of Kwiatkowski et al. (1992) and Leybourne and McCabe (1994) may cause extreme size distortions, if the model under the null hypothesis is highly persistent. The existence of such size distortions has not been recognized in the previous literature. We illustrate the practical importance of these distortions for the problem of testing for long-run purchasing power parity under the recent float. Size distortions of tests of the unit root null hypothesis may be overcome by the use of finite-sample or bootstrap critical values. We show that such corrections are not possible for tests of the null hypothesis of stationarity. Our results suggest that the common practice of viewing tests of stationarity as complementary to tests of the unit root null will tend to result in contradictions or in spurious acceptances of the unit root hypothesis. We conclude that tests of the null hypothesis of stationarity cannot be recommended for applied work unless the sample size is very large.

Suggested Citation

  • Caner, Mehmet & Kilian, Lutz, 1999. "Size distortions of tests of the null hypothesis of stationarity: Evidence and implications for applied work," ZEI Working Papers B 12-1999, University of Bonn, ZEI - Center for European Integration Studies.
  • Handle: RePEc:zbw:zeiwps:b121999
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    Cited by:

    1. Ata Assaf, 2006. "Nonlinear Trend Stationarity in Real Exchange Rates: Evidence from Nonlinear ADF tests," Annals of Economics and Finance, Society for AEF, vol. 7(2), pages 283-294, November.
    2. Diebold, Francis X & Kilian, Lutz, 2000. "Unit-Root Tests Are Useful for Selecting Forecasting Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 18(3), pages 265-273, July.
    3. Guglielmo Maria Caporale & Mario Cerrato, 2006. "Panel data tests of PPP: a critical overview," Applied Financial Economics, Taylor & Francis Journals, vol. 16(1-2), pages 73-91.
    4. Culver, Sarah E. & Papell, David H., 1999. "Long-run purchasing power parity with short-run data: evidence with a null hypothesis of stationarity," Journal of International Money and Finance, Elsevier, vol. 18(5), pages 751-768, October.
    5. Ahmad Zubaidi Baharumshah & Raj Aggarwal & Chan Tze Haw, 2007. "East Asian Real Exchange Rates and PPP: New Evidence from Panel-data Tests," Global Economic Review, Taylor & Francis Journals, vol. 36(2), pages 103-119.

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