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Markov regime-switching and unit root tests

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Author Info
Charles R. Nelson
Jeremy Piger
Eric Zivot

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Abstract

We investigate the power and size performance of unit root tests when the true data generating process undergoes Markov regime-switching. All tests, including those robust to a single break in trend growth rate, have very low power against a process with a Markov-switching trend growth rate as in Lam (1990). However, for the case of business cycle non-linearities, unit root tests are very powerful against models used as alternatives to Lam (1990) that specify regime-switching in the transitory component of output. Under the null hypothesis, the received literature documents size distortions in Dickey-Fuller type tests caused by a single break in trend growth rate or variance. We find these results do not generalize to most parameterizations of Markov-switching in trend or variance. However, Markov-switching in variance can lead to over-rejection in tests robust to a single break in the level of trend.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 683.

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Date of creation: 2000
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Related research
Keywords: Time-series analysis ; Business cycles;

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  2. Dueker, Michael & Fischer, Andreas M., 1996. "Inflation targeting in a small open economy: Empirical results for Switzerland," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 89-103, February. [Downloadable!] (restricted)
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  6. Turner, C.M. & Startz, R. & Nelson, C.R., 1989. "The Markov Model Of Heteroskedasticity, Risk And Learning In The Stock Market," Working Papers 89-01, University of Washington, Department of Economics.
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  7. Leybourne, Stephen J. & C. Mills, Terence & Newbold, Paul, 1998. "Spurious rejections by Dickey-Fuller tests in the presence of a break under the null," Journal of Econometrics, Elsevier, vol. 87(1), pages 191-203, August. [Downloadable!] (restricted)
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  38. Balke, Nathan S. & Fomby, Thomas B., 1991. "Shifting trends, segmented trends, and infrequent permanent shocks," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 61-85, August. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Alberto Humala, 2005. "Interest rate pass-through and financial crises: do switching regimes matter? the case of Argentina," Applied Financial Economics, Taylor and Francis Journals, vol. 15(2), pages 77-94, January. [Downloadable!] (restricted)
  2. Kleopatra Nikolaou, 2006. "The behaviour of the real exchange rate: evidence from regression quantiles," Working Paper Series 667, European Central Bank. [Downloadable!]
  3. Yunus Aksoy & Miguel A. Leon-Ledesma, 2007. "Non-linearities and Unit Roots in G7 Macroeconomic Variables," Birkbeck Working Papers in Economics and Finance 0710, Birkbeck, Department of Economics, Mathematics & Statistics. [Downloadable!]
    Other versions:
  4. Oreste Napolitano, 2006. "Is the Impact of ECB Monetary Policy on EMU Stock Market Returns asymmetric?," Discussion Papers 1_2006, D.E.S. (Department of Economic Studies), University of Naples "Parthenope", Italy. [Downloadable!]
    Other versions:
  5. Kleopatra Nikolaou, 2007. "The behaviour of the real exchange rate: Evidence from regression quantiles," Money Macro and Finance (MMF) Research Group Conference 2006 46, Money Macro and Finance Research Group. [Downloadable!]
  6. Joseph P. Byrne & Roger Perman, 2006. "Unit Roots and Structural Breaks: A Survey of the Literature," Working Papers 2006_10, Department of Economics, University of Glasgow. [Downloadable!]
  7. Ekaterini Panopoulou & B. Groom & P. Koundouri & Theologos Pantelidis, 2005. "Discounting the distant future: How much does model selection affect the certainty equivalent rate?," Economics, Finance and Accounting Department Working Paper Series n1480105, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth. [Downloadable!]
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  8. Hyginus Leon & Serineh Najarian, 2005. "Asymmetric adjustment and nonlinear dynamics in real exchange rates," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 10(1), pages 15-39. [Downloadable!]
  9. Philip Kostov & John Lingard, 2004. "Regime-switching Vector Error Correction Model (VECM) analysis of UK meat consumption," Econometrics 0409007, EconWPA. [Downloadable!]
  10. R. Paap & H.K. van Dijk, 2002. "Bayes estimates of Markov trends in possibly cointegrated series," Econometric Institute Report 295, Erasmus University Rotterdam, Econometric Institute. [Downloadable!]
  11. B. da Silva Lopes, Artur C., 2005. "Finite sample effects of pure seasonal mean shifts on Dickey-Fuller tests," MPRA Paper 125, University Library of Munich, Germany, revised May 2006. [Downloadable!]
  12. Serineh Najarian & H. L. Leon, 2003. "Asymmetric Adjustment and Nonlinear Dynamics in Real Exchange Rates," IMF Working Papers 03/159, International Monetary Fund. [Downloadable!]
  13. repec:bep:mactop:v:8:y:2008:i:1:p:1508-1508 is not listed on IDEAS
    Other versions:
  14. Chew Lian Chua & Sandy Suardi, 2005. "Is There a Unit Root in East-Asian Short-Term Interest Rates?," Melbourne Institute Working Paper Series wp2005n14, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne. [Downloadable!]
  15. Eric Girardin, 2004. "Regime-dependent synchronization of growth cycles between Japan and East Asia," Money Macro and Finance (MMF) Research Group Conference 2004 66, Money Macro and Finance Research Group. [Downloadable!]
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