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Jul 08, 2014

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Stata time series

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8 Aufrufe

Stata time series

© All Rights Reserved

Als PDF, TXT **herunterladen** oder online auf Scribd lesen

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Christopher F Baum

Boston College & DIW

August 2007

Christopher F Baum ( Boston College & DIW) NASUG2007 1 / 26

Powerful new tools for time series analysis Introduction

This presentation discusses two recent developments in time series

analysis by Graham Elliott of UCSD and coauthors and their

implementations as Stata commands, available via ssc.

The rst, urcovar, is a test for a unit root in a time series (Elliott &

Michael Jansson, Journal of Econometrics, 2003) which extends the

ERS dfgls test by adding stationary covariates to gain additional

power.

The second, qll, is based on Elliott and Ulrich Mllers Review of

Economic Studies paper (2006) in which they illustrate that tests for

parameter constancy and tests for an unknown break process can be

unied to produce a single efcient q

LL

test for stability of the

regression function.

Christopher F Baum ( Boston College & DIW) NASUG2007 2 / 26

Powerful new tools for time series analysis Introduction

This presentation discusses two recent developments in time series

analysis by Graham Elliott of UCSD and coauthors and their

implementations as Stata commands, available via ssc.

The rst, urcovar, is a test for a unit root in a time series (Elliott &

Michael Jansson, Journal of Econometrics, 2003) which extends the

ERS dfgls test by adding stationary covariates to gain additional

power.

The second, qll, is based on Elliott and Ulrich Mllers Review of

Economic Studies paper (2006) in which they illustrate that tests for

parameter constancy and tests for an unknown break process can be

unied to produce a single efcient q

LL

test for stability of the

regression function.

Christopher F Baum ( Boston College & DIW) NASUG2007 2 / 26

Powerful new tools for time series analysis Introduction

This presentation discusses two recent developments in time series

analysis by Graham Elliott of UCSD and coauthors and their

implementations as Stata commands, available via ssc.

The rst, urcovar, is a test for a unit root in a time series (Elliott &

Michael Jansson, Journal of Econometrics, 2003) which extends the

ERS dfgls test by adding stationary covariates to gain additional

power.

The second, qll, is based on Elliott and Ulrich Mllers Review of

Economic Studies paper (2006) in which they illustrate that tests for

parameter constancy and tests for an unknown break process can be

unied to produce a single efcient q

LL

test for stability of the

regression function.

Christopher F Baum ( Boston College & DIW) NASUG2007 2 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

urcovar

The presence of a unit root in the time series representation of a

variable has important implications for both the econometric method

used and the economic interpretation of the model in which that

variable appears.

The rst generation tests of Dickey and Fuller (dfuller) and Phillips

and Perron (pperron) have been supplanted by more powerful

second generation tests such as dfgls of ElliottRothenbergStock.

ERS showed that there is no uniformly most powerful test, but that

their DF-GLS alternative is approximately most powerful for the unit

root testing problem.

Christopher F Baum ( Boston College & DIW) NASUG2007 3 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

urcovar

The presence of a unit root in the time series representation of a

variable has important implications for both the econometric method

used and the economic interpretation of the model in which that

variable appears.

The rst generation tests of Dickey and Fuller (dfuller) and Phillips

and Perron (pperron) have been supplanted by more powerful

second generation tests such as dfgls of ElliottRothenbergStock.

ERS showed that there is no uniformly most powerful test, but that

their DF-GLS alternative is approximately most powerful for the unit

root testing problem.

Christopher F Baum ( Boston College & DIW) NASUG2007 3 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

As is well known in the applied economics literature, even a test with

DF-GLSs favorable characteristics may still lack power to distinguish

between the null hypothesis of nonstationary behavior (I(1)) and the

stationary alternative (I(0)).

In many applications, using a longer time series is not feasible due to

known structural breaks, institutional changes, and the like. Another

potential alternative, the panel unit root test, brings its own set of

complications (do we assume all series are I(1)? that all are I(0)?).

Christopher F Baum ( Boston College & DIW) NASUG2007 4 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

As is well known in the applied economics literature, even a test with

DF-GLSs favorable characteristics may still lack power to distinguish

between the null hypothesis of nonstationary behavior (I(1)) and the

stationary alternative (I(0)).

In many applications, using a longer time series is not feasible due to

known structural breaks, institutional changes, and the like. Another

potential alternative, the panel unit root test, brings its own set of

complications (do we assume all series are I(1)? that all are I(0)?).

Christopher F Baum ( Boston College & DIW) NASUG2007 4 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

Elliott and Jansson addressed this issue by considering a model in

which there is one potentially nonstationary (I(1)) series, y, which

potentially covaries with some available stationary variables, x. This

idea was rst put forth by Bruce Hansen in 1995 who proposed a

covariate augmented DF test, or CADF test and showed that this test

had greater power than those which ignored the covariates.

Elliott and Jansson extended Hansens results to show that such a test

could be conducted in the presence of unknown nuisance parameters,

and with constants and trends in the model. Their proposed test may

be readily calculated by estimating a vector autoregression (var) in the

{y, x} variables and performing a sequence of matrix manipulations.

Christopher F Baum ( Boston College & DIW) NASUG2007 5 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

Elliott and Jansson addressed this issue by considering a model in

which there is one potentially nonstationary (I(1)) series, y, which

potentially covaries with some available stationary variables, x. This

idea was rst put forth by Bruce Hansen in 1995 who proposed a

covariate augmented DF test, or CADF test and showed that this test

had greater power than those which ignored the covariates.

Elliott and Jansson extended Hansens results to show that such a test

could be conducted in the presence of unknown nuisance parameters,

and with constants and trends in the model. Their proposed test may

be readily calculated by estimating a vector autoregression (var) in the

{y, x} variables and performing a sequence of matrix manipulations.

Christopher F Baum ( Boston College & DIW) NASUG2007 5 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The model considered is:

z

t

=

0

+

1

t +u

t

, t = 1, . . . , T

A(L)

(1 L)u

y,t

u

x,t

= e

t

with z

t

= {y

t

, x

t

}

, x

t

an m 1 vector,

0

= {

y0

,

x0

}

,

1

= {

y1

,

x1

}

and u

t

= {u

y,t

, u

x,t

}

.

A(L) is a stable matrix polynomial of nite order k in the lag operator L.

This is a vector autoregression (VAR) in the model of x and the

quasi-difference of y. The relevant test is that the parameter is equal

to unity, implying that y has a unit root, against alternatives that is

less than one.

Christopher F Baum ( Boston College & DIW) NASUG2007 6 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The model considered is:

z

t

=

0

+

1

t +u

t

, t = 1, . . . , T

A(L)

(1 L)u

y,t

u

x,t

= e

t

with z

t

= {y

t

, x

t

}

, x

t

an m 1 vector,

0

= {

y0

,

x0

}

,

1

= {

y1

,

x1

}

and u

t

= {u

y,t

, u

x,t

}

.

A(L) is a stable matrix polynomial of nite order k in the lag operator L.

This is a vector autoregression (VAR) in the model of x and the

quasi-difference of y. The relevant test is that the parameter is equal

to unity, implying that y has a unit root, against alternatives that is

less than one.

Christopher F Baum ( Boston College & DIW) NASUG2007 6 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The potential gain in this test depends on the R

2

between y and the

set of x covariates. As Elliott and Pesavento (J. Money, Credit,

Banking 2006) point out, the relevant issue is the ability of a unit root

test to have power to distinguish between I(1) and a local alternative.

The local alternative is in terms of c = T( 1) where is the largest

root in the AR representation of y.

How far below unity must fall to give a unit root test the ability to

discern stationary, mean-reverting behavior (albeit with strong

persistence, with > 0.9) from nonstationary, unit root behavior? The

various tests in this literature differ in their power against relevant local

alternatives.

Christopher F Baum ( Boston College & DIW) NASUG2007 7 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The potential gain in this test depends on the R

2

between y and the

set of x covariates. As Elliott and Pesavento (J. Money, Credit,

Banking 2006) point out, the relevant issue is the ability of a unit root

test to have power to distinguish between I(1) and a local alternative.

The local alternative is in terms of c = T( 1) where is the largest

root in the AR representation of y.

How far below unity must fall to give a unit root test the ability to

discern stationary, mean-reverting behavior (albeit with strong

persistence, with > 0.9) from nonstationary, unit root behavior? The

various tests in this literature differ in their power against relevant local

alternatives.

Christopher F Baum ( Boston College & DIW) NASUG2007 7 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The c parameter can be expressed in terms of the half-life (k) of a

shock, where a unit root implies an innite half-life:

k = log(0.5)/ log(). When related to the local alternative,

k/T = log(0.5)/c. For about 120 observations (30 years of quarterly

data), c = 5 corresponds to a half-life of 16.8 time periods (over four

years at a quarterly frequency). From Elliott, Rothenberg, Stock (ERS,

Econometrica, 1996), the standard Dickey-Fuller test (dfuller)has

12% power to reject the alternative. The ERS DF-GLS test (dfgls)

has 32% power.

In contrast, with an R

2

= 0.2, the ElliottJansson (EJ) test has power

of 42%. The power rises to 53% (69%) for R

2

= 0.4 (0.6). For higher

absolute values of c (shorter half-lives), the gains are smaller. For

c = 10, or a half-life of 8.4 periods, the power of the D-F (DF-GLS)

test is 31% (75%). The EJ test has power of 88%, 94% and 99% for

R

2

= 0.2, 0.4, 0.6. One clear conclusion: DF-GLS always has superior

power compared to dfuller.

Christopher F Baum ( Boston College & DIW) NASUG2007 8 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The c parameter can be expressed in terms of the half-life (k) of a

shock, where a unit root implies an innite half-life:

k = log(0.5)/ log(). When related to the local alternative,

k/T = log(0.5)/c. For about 120 observations (30 years of quarterly

data), c = 5 corresponds to a half-life of 16.8 time periods (over four

years at a quarterly frequency). From Elliott, Rothenberg, Stock (ERS,

Econometrica, 1996), the standard Dickey-Fuller test (dfuller)has

12% power to reject the alternative. The ERS DF-GLS test (dfgls)

has 32% power.

In contrast, with an R

2

= 0.2, the ElliottJansson (EJ) test has power

of 42%. The power rises to 53% (69%) for R

2

= 0.4 (0.6). For higher

absolute values of c (shorter half-lives), the gains are smaller. For

c = 10, or a half-life of 8.4 periods, the power of the D-F (DF-GLS)

test is 31% (75%). The EJ test has power of 88%, 94% and 99% for

R

2

= 0.2, 0.4, 0.6. One clear conclusion: DF-GLS always has superior

power compared to dfuller.

Christopher F Baum ( Boston College & DIW) NASUG2007 8 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

Like other unit root tests, you must specify the deterministic model

assumed for y. As in dfgls, you can specify that the model contains

no deterministic terms, a constant, or constant and trend. But as the

ElliottJansson model contains one or more x variables as well, you

may also specify that those variables deterministic model contains no

deterministic terms, a constant, or constant and trend.

Five cases are dened:

1

No constant nor trend in model

2

Constant in y only

3

Constants in both {y, x}

4

Constant and trend in y, constant in x

5

No restrictions

Christopher F Baum ( Boston College & DIW) NASUG2007 9 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

Like other unit root tests, you must specify the deterministic model

assumed for y. As in dfgls, you can specify that the model contains

no deterministic terms, a constant, or constant and trend. But as the

ElliottJansson model contains one or more x variables as well, you

may also specify that those variables deterministic model contains no

deterministic terms, a constant, or constant and trend.

Five cases are dened:

1

No constant nor trend in model

2

Constant in y only

3

Constants in both {y, x}

4

Constant and trend in y, constant in x

5

No restrictions

Christopher F Baum ( Boston College & DIW) NASUG2007 9 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

Like other unit root tests, you must specify the deterministic model

assumed for y. As in dfgls, you can specify that the model contains

no deterministic terms, a constant, or constant and trend. But as the

ElliottJansson model contains one or more x variables as well, you

may also specify that those variables deterministic model contains no

deterministic terms, a constant, or constant and trend.

Five cases are dened:

1

No constant nor trend in model

2

Constant in y only

3

Constants in both {y, x}

4

Constant and trend in y, constant in x

5

No restrictions

Christopher F Baum ( Boston College & DIW) NASUG2007 9 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

Like other unit root tests, you must specify the deterministic model

assumed for y. As in dfgls, you can specify that the model contains

no deterministic terms, a constant, or constant and trend. But as the

ElliottJansson model contains one or more x variables as well, you

may also specify that those variables deterministic model contains no

deterministic terms, a constant, or constant and trend.

Five cases are dened:

1

No constant nor trend in model

2

Constant in y only

3

Constants in both {y, x}

4

Constant and trend in y, constant in x

5

No restrictions

Christopher F Baum ( Boston College & DIW) NASUG2007 9 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

Like other unit root tests, you must specify the deterministic model

assumed for y. As in dfgls, you can specify that the model contains

no deterministic terms, a constant, or constant and trend. But as the

ElliottJansson model contains one or more x variables as well, you

may also specify that those variables deterministic model contains no

deterministic terms, a constant, or constant and trend.

Five cases are dened:

1

No constant nor trend in model

2

Constant in y only

3

Constants in both {y, x}

4

Constant and trend in y, constant in x

5

No restrictions

Christopher F Baum ( Boston College & DIW) NASUG2007 9 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The urcovar Stata command implements the EJ test using Mata to

perform a complicated sequence of matrix manipulations that produce

the test statistic. EJs Table 1 of asymptotic critical values is stored in

the program and used to produce a critical value corresponding to the

R

2

for your data. The command syntax:

urcovar depvar varlist [if exp] [in range] [ , maxlag(#) case[#) rstobs ]

where the case option species the deterministic model, with default

of case 1. The maxlag option species the number of lags to be used

in computing the VAR (default 1). The firstobs option species that

the rst observation of depvar should be used to dene the rst

quasi-difference (rather than zero). The urcovar command is

available for Stata 9.2 or Stata 10 from ssc.

Christopher F Baum ( Boston College & DIW) NASUG2007 10 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

As an illustration of urcovar use, we consider an experiment similar

to that tested in EJ, who in turn refer to a BlanchardQuah model. The

variable of interest is U.S. personal income (PINCOME). The single

stationary covariate to be considered is the U.S. unemployment rate

(UNRATE). Both are acquired from the FRED database with the

freduse command (Drukker, Stata Journal, 2006) and have been

converted to the common quarterly frequency for 1950Q21987Q4

using tscollap (Baum, STB-57, 2000).

We rst present a line plot of these two series, then the output from a

conventional DF-GLS test, followed by the output from urcovar,

cases 3 and 5. The maxlag considered in both the dfgls and

urcovar tests is set to eight quarters.

Christopher F Baum ( Boston College & DIW) NASUG2007 11 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

2

2

24

4

46

6

68

8

810

1

0

10 Unemployment Rate

U

n

e

m

p

l

o

y

m

e

n

t

R

a

t

e

Unemployment Rate 0

0

01000

1

0

0

0

1000 2000

2

0

0

0

2000 3000

3

0

0

0

3000 4000

4

0

0

0

4000 Personal Income

P

e

r

s

o

n

a

l

I

n

c

o

m

e

Personal Income 1950q1

1950q1

1950q1 1960q1

1960q1

1960q1 1970q1

1970q1

1970q1 1980q1

1980q1

1980q1 1990q1

1990q1

1990q1 Quarter

Quarter

Quarter Personal Income

Personal Income

Personal Income Unemployment Rate

Unemployment Rate

Unemployment Rate

Christopher F Baum ( Boston College & DIW) NASUG2007 12 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

. dfgls PINCOME, maxlag(8) trend

DF-GLS for PINCOME Number of obs = 142

DF-GLS tau 1% Critical 5% Critical 10% Critical

[lags] Test Statistic Value Value Value

8 -0.830 -3.519 -2.875 -2.593

7 -0.585 -3.519 -2.890 -2.607

6 -0.173 -3.519 -2.905 -2.620

5 -0.071 -3.519 -2.918 -2.633

4 -0.272 -3.519 -2.932 -2.645

3 -0.334 -3.519 -2.944 -2.656

2 0.332 -3.519 -2.955 -2.666

1 0.655 -3.519 -2.966 -2.676

Opt Lag (Ng-Perron seq t) = 8 with RMSE 11.44531

Min SC = 5.103851 at lag 3 with RMSE 11.96667

Min MAIC = 5.000489 at lag 7 with RMSE 11.56349

Christopher F Baum ( Boston College & DIW) NASUG2007 13 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

. urcovar PINCOME UNRATE, maxlag(8) case(3)

Elliott-Jansson unit root test for PINCOME 1950q2 - 1987q4

Number of obs: 143

Stationary covariates: UNRATE

Deterministic model: Case 3

Maximum lag order: 8

Estimated R-squared: 0.9950

H0: rho = 1 [ PINCOME is I(1) ]

H1: rho < 1 [ PINCOME is I(0) ]

Reject H0 if Lambda < critical value

Lambda: 11.8307

5% critical value: 17.9900

. urcovar PINCOME UNRATE, maxlag(8) case(5)

Elliott-Jansson unit root test for PINCOME 1950q2 - 1987q4

Number of obs: 143

Stationary covariates: UNRATE

Deterministic model: Case 5

Maximum lag order: 8

Estimated R-squared: 0.8407

H0: rho = 1 [ PINCOME is I(1) ]

H1: rho < 1 [ PINCOME is I(0) ]

Reject H0 if Lambda < critical value

Lambda: 17.1558

5% critical value: 29.1170

Christopher F Baum ( Boston College & DIW) NASUG2007 14 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The DF-GLS test is unable to reject its null of I(1) at any reasonable

level of signicance. When we augment the test with the stationary

covariate in the EJ test, quite different results are forthcoming. Case 3

allows for constant terms (but no trends) in both the quasi-difference of

PINCOME and UNRATE. The R

2

in this system is over 0.99. Case 5

allows constant terms and trends in both equations of the VAR, with an

R

2

of 0.84.

Like the DF-GLS test, the EJ test has a null hypothesis of

nonstationarity (I(1)). The EJ test statistic, , must be compared with

the interpolated 5% critical value. A value of smaller than the

tabulated value leads to a rejection, and vice versa. In both cases, we

may reject the null hypothesis at the 95% level of condence in favor of

the alternative hypothesis of stationarity.

Christopher F Baum ( Boston College & DIW) NASUG2007 15 / 26

Powerful new tools for time series analysis Unit root test with additional covariates

The DF-GLS test is unable to reject its null of I(1) at any reasonable

level of signicance. When we augment the test with the stationary

covariate in the EJ test, quite different results are forthcoming. Case 3

allows for constant terms (but no trends) in both the quasi-difference of

PINCOME and UNRATE. The R

2

in this system is over 0.99. Case 5

allows constant terms and trends in both equations of the VAR, with an

R

2

of 0.84.

Like the DF-GLS test, the EJ test has a null hypothesis of

nonstationarity (I(1)). The EJ test statistic, , must be compared with

the interpolated 5% critical value. A value of smaller than the

tabulated value leads to a rejection, and vice versa. In both cases, we

may reject the null hypothesis at the 95% level of condence in favor of

the alternative hypothesis of stationarity.

Christopher F Baum ( Boston College & DIW) NASUG2007 15 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

qll

Elliott and Mllers 2006 paper in Review of Economic Studies (EM)

addresses the large literature on testing a time series model for

structural stability. They consider tests of the null hypothesis of a

stable linear model

y

t

= X

t

+Z

t

+

against the alternative of a partially unstable model

y

t

= X

t

+Z

t

+

where the variation in

t

is of the strong form (p. 907), or nontrivial.

Christopher F Baum ( Boston College & DIW) NASUG2007 16 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

Consideration of this alternative has led to a huge literature based on

the diversity of possible ways {

t

} can be non-constant. EM point out

that optimal tests and their asymptotic distributions have not been

derived for many particular models of the alternative.

Their approach develops a single unied framework, noting that the

seemingly different approaches of structural breaks and random

coefcients are in fact equivalent. (p.908) EM unify the approaches

that describe a breaking process with a number of non-random

parameters with tests that specify stochastic processes for {

t

}

without requiring to specify its exact evolution.

The processes considered include breaks that occur in a random

fashion, serial correlation in the changes of the coefcients, a

clustering of break dates, and so on. Under a normality assumption on

the disturbances, small sample efcient tests in this broad set are

asymptotically equivalent and leaving the exact breaking process

unspecied (apart from a scaling parameter) does not result in a loss

of power in large samples. (p. 908)

Christopher F Baum ( Boston College & DIW) NASUG2007 17 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

Consideration of this alternative has led to a huge literature based on

the diversity of possible ways {

t

} can be non-constant. EM point out

that optimal tests and their asymptotic distributions have not been

derived for many particular models of the alternative.

Their approach develops a single unied framework, noting that the

seemingly different approaches of structural breaks and random

coefcients are in fact equivalent. (p.908) EM unify the approaches

that describe a breaking process with a number of non-random

parameters with tests that specify stochastic processes for {

t

}

without requiring to specify its exact evolution.

The processes considered include breaks that occur in a random

fashion, serial correlation in the changes of the coefcients, a

clustering of break dates, and so on. Under a normality assumption on

the disturbances, small sample efcient tests in this broad set are

asymptotically equivalent and leaving the exact breaking process

unspecied (apart from a scaling parameter) does not result in a loss

of power in large samples. (p. 908)

Christopher F Baum ( Boston College & DIW) NASUG2007 17 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

Consideration of this alternative has led to a huge literature based on

the diversity of possible ways {

t

} can be non-constant. EM point out

that optimal tests and their asymptotic distributions have not been

derived for many particular models of the alternative.

Their approach develops a single unied framework, noting that the

seemingly different approaches of structural breaks and random

coefcients are in fact equivalent. (p.908) EM unify the approaches

that describe a breaking process with a number of non-random

parameters with tests that specify stochastic processes for {

t

}

without requiring to specify its exact evolution.

The processes considered include breaks that occur in a random

fashion, serial correlation in the changes of the coefcients, a

clustering of break dates, and so on. Under a normality assumption on

the disturbances, small sample efcient tests in this broad set are

asymptotically equivalent and leaving the exact breaking process

unspecied (apart from a scaling parameter) does not result in a loss

of power in large samples. (p. 908)

Christopher F Baum ( Boston College & DIW) NASUG2007 17 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

The consequences of this approach to the problem of structural

stability are profound. The equivalence of power over many models

means that there is little point in deriving further optimal tests for

particular processes in our set (p. 908) and the researcher can carry

out (almost) efcient inference without specifying the exact path of the

breaking process.

Furthermore, the computation of EMs Quasi-Local Level (q

LL

) test

statistic is straightforward, and it remains valid for very general

specications of the error term and covariates. The computation

requires no more than (k +1) OLS regressions for a model with k

covariates, in contrast to many approaches which require T or T

2

regressions. No arbitrary trimming of the data is required.

Christopher F Baum ( Boston College & DIW) NASUG2007 18 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

The consequences of this approach to the problem of structural

stability are profound. The equivalence of power over many models

means that there is little point in deriving further optimal tests for

particular processes in our set (p. 908) and the researcher can carry

out (almost) efcient inference without specifying the exact path of the

breaking process.

Furthermore, the computation of EMs Quasi-Local Level (q

LL

) test

statistic is straightforward, and it remains valid for very general

specications of the error term and covariates. The computation

requires no more than (k +1) OLS regressions for a model with k

covariates, in contrast to many approaches which require T or T

2

regressions. No arbitrary trimming of the data is required.

Christopher F Baum ( Boston College & DIW) NASUG2007 18 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

In the structural break literature, a xed number of N breaks at

1

, . . . ,

N

are assumed. Much of the literature addresses N = 1: e.g.

the Chow test, cusums tests of BrownDurbinEvans, Bai and

Perron, Andrews and Ploberger, etc.

In contrast, the time-varying parameter literature considers a random

process generating

t

: often considered as a random walk process.

The approaches of Leybourne and McCabe, Nyblom, and Saikkonen

and Luukonen are based on classical statistics, while Koop and Potter

and Giordani et al. consider a Bayesian approach. All of these

approaches are very analytically challenging.

EM argue that tests for one of these phenomena will have power

against the other, and vice versa. Therefore a single approach will

sufce.

Christopher F Baum ( Boston College & DIW) NASUG2007 19 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

In the structural break literature, a xed number of N breaks at

1

, . . . ,

N

are assumed. Much of the literature addresses N = 1: e.g.

the Chow test, cusums tests of BrownDurbinEvans, Bai and

Perron, Andrews and Ploberger, etc.

In contrast, the time-varying parameter literature considers a random

process generating

t

: often considered as a random walk process.

The approaches of Leybourne and McCabe, Nyblom, and Saikkonen

and Luukonen are based on classical statistics, while Koop and Potter

and Giordani et al. consider a Bayesian approach. All of these

approaches are very analytically challenging.

EM argue that tests for one of these phenomena will have power

against the other, and vice versa. Therefore a single approach will

sufce.

Christopher F Baum ( Boston College & DIW) NASUG2007 19 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

In the structural break literature, a xed number of N breaks at

1

, . . . ,

N

are assumed. Much of the literature addresses N = 1: e.g.

the Chow test, cusums tests of BrownDurbinEvans, Bai and

Perron, Andrews and Ploberger, etc.

In contrast, the time-varying parameter literature considers a random

process generating

t

: often considered as a random walk process.

The approaches of Leybourne and McCabe, Nyblom, and Saikkonen

and Luukonen are based on classical statistics, while Koop and Potter

and Giordani et al. consider a Bayesian approach. All of these

approaches are very analytically challenging.

EM argue that tests for one of these phenomena will have power

against the other, and vice versa. Therefore a single approach will

sufce.

Christopher F Baum ( Boston College & DIW) NASUG2007 19 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

EM raise the interesting question: why do we test for parameter

constancy? They consider three motivations:

1

Stability relates to theoretical constructs such as the Lucas

critique of economic policymaking

2

Forecasting will depend crucially on a stable relationship

3

Standard inference on

will be useless if {

t

} varies in a

permanent fashion; persistent changes will render a xed model

misleading

The more pervasive these three motivations are, the more persistent

the changes in {}. (p. 912) Therefore, EM propose that a useful test

should maximize its power against persistent changes in {

t

}.

Christopher F Baum ( Boston College & DIW) NASUG2007 20 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

EM raise the interesting question: why do we test for parameter

constancy? They consider three motivations:

1

Stability relates to theoretical constructs such as the Lucas

critique of economic policymaking

2

Forecasting will depend crucially on a stable relationship

3

Standard inference on

will be useless if {

t

} varies in a

permanent fashion; persistent changes will render a xed model

misleading

The more pervasive these three motivations are, the more persistent

the changes in {}. (p. 912) Therefore, EM propose that a useful test

should maximize its power against persistent changes in {

t

}.

Christopher F Baum ( Boston College & DIW) NASUG2007 20 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

EM raise the interesting question: why do we test for parameter

constancy? They consider three motivations:

1

Stability relates to theoretical constructs such as the Lucas

critique of economic policymaking

2

Forecasting will depend crucially on a stable relationship

3

Standard inference on

will be useless if {

t

} varies in a

permanent fashion; persistent changes will render a xed model

misleading

The more pervasive these three motivations are, the more persistent

the changes in {}. (p. 912) Therefore, EM propose that a useful test

should maximize its power against persistent changes in {

t

}.

Christopher F Baum ( Boston College & DIW) NASUG2007 20 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

EM raise the interesting question: why do we test for parameter

constancy? They consider three motivations:

1

Stability relates to theoretical constructs such as the Lucas

critique of economic policymaking

2

Forecasting will depend crucially on a stable relationship

3

Standard inference on

will be useless if {

t

} varies in a

permanent fashion; persistent changes will render a xed model

misleading

The more pervasive these three motivations are, the more persistent

the changes in {}. (p. 912) Therefore, EM propose that a useful test

should maximize its power against persistent changes in {

t

}.

Christopher F Baum ( Boston College & DIW) NASUG2007 20 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

The conditions underlying the EM test allow for diverse breaking

models, from relatively rare (including a single break) to very frequent

small breaks (such as breaks every period with probability p). Breaks

can also occur with a regular pattern, such as every 16 quarters

following U.S. presidential elections.

Computation of the q

LL

test statistic is straightforward, relying only on

OLS regressions and construction of an estimate of the long-run

covariance matrix of {X

t

t

}. For uncorrelated

t

, a robust covariance

matrix will sufce. For possibly autocorrelated

t

, a HAC

(NeweyWest) covariance matrix is appropriate.

The null hypothesis of parameter stability is rejected for small values

of

q

LL

: that is, values more negative than the critical values.

Asymptotic critical values are provided by EM for k = 1, . . . , 10 and are

independent of the dimension of Z

t

(the set of covariates assumed to

have stable coefcients).

Christopher F Baum ( Boston College & DIW) NASUG2007 21 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

The conditions underlying the EM test allow for diverse breaking

models, from relatively rare (including a single break) to very frequent

small breaks (such as breaks every period with probability p). Breaks

can also occur with a regular pattern, such as every 16 quarters

following U.S. presidential elections.

Computation of the q

LL

test statistic is straightforward, relying only on

OLS regressions and construction of an estimate of the long-run

covariance matrix of {X

t

t

}. For uncorrelated

t

, a robust covariance

matrix will sufce. For possibly autocorrelated

t

, a HAC

(NeweyWest) covariance matrix is appropriate.

The null hypothesis of parameter stability is rejected for small values

of

q

LL

: that is, values more negative than the critical values.

Asymptotic critical values are provided by EM for k = 1, . . . , 10 and are

independent of the dimension of Z

t

(the set of covariates assumed to

have stable coefcients).

Christopher F Baum ( Boston College & DIW) NASUG2007 21 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

The conditions underlying the EM test allow for diverse breaking

models, from relatively rare (including a single break) to very frequent

small breaks (such as breaks every period with probability p). Breaks

can also occur with a regular pattern, such as every 16 quarters

following U.S. presidential elections.

Computation of the q

LL

test statistic is straightforward, relying only on

OLS regressions and construction of an estimate of the long-run

covariance matrix of {X

t

t

}. For uncorrelated

t

, a robust covariance

matrix will sufce. For possibly autocorrelated

t

, a HAC

(NeweyWest) covariance matrix is appropriate.

The null hypothesis of parameter stability is rejected for small values

of

q

LL

: that is, values more negative than the critical values.

Asymptotic critical values are provided by EM for k = 1, . . . , 10 and are

independent of the dimension of Z

t

(the set of covariates assumed to

have stable coefcients).

Christopher F Baum ( Boston College & DIW) NASUG2007 21 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

The qll Stata command implements the EM q

LL

test using Mata to

produce the test statistic. EMs Table 1 of asymptotic critical values is

stored in the program and used to produce 10%, 5% and 1% critical

values corresponding to number of regressors with potentially unstable

parameters. The command syntax:

qll depvar varlist [if exp] [in range] [ , (zvarlist) rlag(#) ]

where the parenthesized zvarlist optionally species the list of

covariates assumed to have stable coefcients (none are required).

The rlag option species the number of lags to be used in computing

the long-run covariance matrix of {X

t

t

}. If a negative value is given,

the optimal lag order is chosen by the BIC criterion. The qll

command is available for Stata 9.2 or Stata 10 from ssc.

We consider a regression of ination on the lagged unemployment

rate, the Treasury bill rate and the Treasury bond rate. We assume the

latter two coefcients are stable over the period. We test over the full

sample and a 19902000 subsample.

Christopher F Baum ( Boston College & DIW) NASUG2007 22 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

The qll Stata command implements the EM q

LL

test using Mata to

produce the test statistic. EMs Table 1 of asymptotic critical values is

stored in the program and used to produce 10%, 5% and 1% critical

values corresponding to number of regressors with potentially unstable

parameters. The command syntax:

qll depvar varlist [if exp] [in range] [ , (zvarlist) rlag(#) ]

where the parenthesized zvarlist optionally species the list of

covariates assumed to have stable coefcients (none are required).

The rlag option species the number of lags to be used in computing

the long-run covariance matrix of {X

t

t

}. If a negative value is given,

the optimal lag order is chosen by the BIC criterion. The qll

command is available for Stata 9.2 or Stata 10 from ssc.

We consider a regression of ination on the lagged unemployment

rate, the Treasury bill rate and the Treasury bond rate. We assume the

latter two coefcients are stable over the period. We test over the full

sample and a 19902000 subsample.

Christopher F Baum ( Boston College & DIW) NASUG2007 22 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

4

4

46

6

68

8

810

1

0

10 12

1

2

12 Unemployment Rate

U

n

e

m

p

l

o

y

m

e

n

t

R

a

t

e

Unemployment Rate 0

0

05

5

510

1

0

10 15

1

5

15 CPI Inflation

C

P

I

I

n

f

l

a

t

i

o

n

CPI Inflation 1960q1

1960q1

1960q1 1970q1

1970q1

1970q1 1980q1

1980q1

1980q1 1990q1

1990q1

1990q1 2000q1

2000q1

2000q1 date

date

date CPI Inflation

CPI Inflation

CPI Inflation Unemployment Rate

Unemployment Rate

Unemployment Rate

Christopher F Baum ( Boston College & DIW) NASUG2007 23 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

. qll inf L.UR (TBILL TBON), rlag(8)

Elliott-Mller qLL test statistic for time varying coefficients

in the model of inf, 1960q1 - 2000q4

Allowing for time variation in 1 regressors

H0: all regression coefficients fixed over the sample period (N = 164)

Test stat. 1% Crit.Val. 5% Crit.Val. 10% Crit.Val.

-2.260 -11.05 -8.36 -7.14

Long-run variance computed with 8 lags.

. qll inf L.UR (TBILL TBON) if tin(1990q1,), rlag(8)

Elliott-Mller qLL test statistic for time varying coefficients

in the model of inf, 1990q1 - 2000q4

Allowing for time variation in 1 regressors

H0: all regression coefficients fixed over the sample period (N = 44)

Test stat. 1% Crit.Val. 5% Crit.Val. 10% Crit.Val.

-6.647 -11.05 -8.36 -7.14

Long-run variance computed with 8 lags.

Christopher F Baum ( Boston College & DIW) NASUG2007 24 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

In both samples, using eight lags to calculate the long-run covariance

matrix, the null hypothesis that the coefcients on the lagged

unemployment rate (L.UR) are stable cannot be rejected at the 10%

level of condence. The ElliottMller q

LL

test indicates that the

stability of this regression model, allowing for instability in the

coefcient of the unemployment rate only, cannot be rejected by the

data.

Christopher F Baum ( Boston College & DIW) NASUG2007 25 / 26

Powerful new tools for time series analysis The q

LL

test for stability of the regression function

Acknowledgements

I am grateful to Graham Elliott for his cogent presentation of his

techniques during his visit to Boston College in spring 2007, for helpful

discussions of the methodology and for his MATLAB code

implementing the qll routine. Remaining errors are my own.

Christopher F Baum ( Boston College & DIW) NASUG2007 26 / 26

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