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THE PROPERTIES OF KULLBACK–LEIBLER DIVERGENCE FOR THE UNIT ROOT HYPOTHESIS

Published online by Cambridge University Press:  01 December 2009

Patrick Marsh
Patrick Marsh*
Affiliation:
University of York
*
*Address correspondence to Patrick Marsh, Department of Economics, University of York, Heslington, York, United Kingdom, YO10 5DD; e-mail: [email protected].
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Abstract

The fundamental contributions made by Paul Newbold have highlighted how crucial it is to detect when economic time series have unit roots. This paper explores the effects that model specification has on our ability to do that. Asymptotic power, a natural choice to quantify these effects, does not accurately predict finite-sample power. Instead, here the Kullback–Leibler divergence between the unit root null and any alternative is used and its numeric and analytic properties detailed. Numerically it behaves in a similar way to finite-sample power. However, because it is analytically available we are able to prove that it is a minimizable function of the degree of trending in any included deterministic component and of the correlation of the underlying innovations. It is explicitly confirmed, therefore, that it is approximately linear trends and negative unit root moving average innovations that minimize the efficacy of unit root inferential tools. Applied to the Nelson and Plosser macroeconomic series the effect that different types of trends included in the model have on unit root inference is clearly revealed.

Type
ARTICLES
Information
Econometric Theory , Volume 25 , Issue 6: Newbold Conference Special Issue , December 2009 , pp. 1662 - 1681
Copyright
Copyright © Cambridge University Press 2009

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