Unit root econometrics and economic nonlinearities |
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Affiliation: | 1. School of Urban Planning, McGill University, Canada;2. School of Urban Planning, Room 415 Macdonald-Harrington Building 815 Rue Sherbrooke O #400, McGill University, Montréal, QC H3A 0C2, Canada;1. Department of International Finance, Hankuk University of Foreign Studies, Yongin-si, Gyeonggi-do, South Korea;2. Department of Economics, Sungkyunkwan University, 25-2 Sungkyunkwan-ro, Jongno-gu, Seoul, South Korea;1. Bangladesh Bank, Motijheel C/A, Dhaka, 1000, Bangladesh;2. Department of Quantitative Sciences, International University of Business Agriculture and Technology (IUBAT), 4 Embankment Drive Road, Sector-10, Uttara, Dhaka, 1230, Bangladesh;3. BRAC Business School, BRAC University, 66 Mohakhali, Dhaka, 1212, Bangladesh |
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Abstract: | This paper concentrates on some shortcomings of contemporary unit root econometric methodology (testing for cointegration, common roots and stationarity) where the dynamics of an economy are described by a nonlinear process. It is shown that, in such circumstances, traditionally applied unit root econometrics may not lead to interpretable or statistically significant results. Two cases of such nonlinearities are discussed: (i) a stochastically nonlinear data generating process and (ii) a time-varying parameters cointegrating relation, typical of an economic reform process. It is shown that case (i) consists of a wide family of economic processes and in most such cases the results of standard unit root tests are not directly interpretable. Case (ii) does not result in a (conventionally understood) error-correction representation of a cointegrated process. Some Monte Carlo experiments evaluate the validity of cointegration tests in situations where there is a change in the cointegration parameter and from cointegration regime to noncointegration and vice versa. A simple method of estimation through simulation is proposed and its finite-sample properties examined. |
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