Joint hypothesis specification for unit root tests with a structural break

Abstract

Summary Several tests based on a t‐ratio have been proposed in the literature to decide the order of integration of a time series allowing for a structural break. However, another approach based on testing a joint hypothesis of unit root and the irrelevance of some nuisance parameters is also feasible. This paper proposes new unit root tests consistent with the presence of a structural break applying this second perspective. Our approach deals both with the case where the break is not allowed under the null hypothesis, and where it is allowed. Simulations investigate the performance of this proposal compared to the existing tests and show important gains in terms of power.

Time series analysis of financial stability of banks: Evidence from Saudi Arabia

“…We will follow this route, running first the standard Engle–Granger tests (which are more parsimonious and, hence, more suitable for our data set than Johansen's system tests) for all banks. In the case of RYD, the presence of a clear break in the constant suggested the use of a test that allows for varying parameters—namely, the Carrion‐i‐Silvestre and Sansó (2006) generalization of the KPSS test of cointegration with breaks 14 . For all banks, we included only non‐stationary variables, so that income diversity (ID) was never included in the model and operating cost–income ratio (CI) was included only for RJH.…”