AR(1) MODELS, UNIT ROOTS, AND ADJUSTED PROFILE LIKELIHOOD

Pekka Pere

Econometric Theory, 2003, vol. 19, issue 6, 885-922

Abstract: An unobserved components and a conventional first-order autoregressive (AR) model with constant are analyzed with the adjusted profile likelihood of Cox and Reid (1987, Journal of the Royal Statistical Society, Series B 49, 1–39; 1993, Journal of the Royal Statistical Society, Series B 55, 467–71). Both the unobserved components model and the Cox–Reid adjustment can provide more accurate estimates of an AR coefficient of unity. The unobserved components model yields more powerful unit-root tests. In general the most powerful test utilizes the adjustment. Under the unobserved components model the adjusted statistics follow the asymptotic distributions better than the unadjusted.The basis of this research is my D. Phil. thesis (1997) for the University of Oxford. I am grateful to David Hendry for supervision and to Pentti Saikkonen for most helpful advice. I appreciate also the CBRT Young Economist Award with which I was honored after presenting a previous version at the 1998 erc/METU International Conference on Economics. I remain responsible for any errors. Financial support by the Yrjö Jahnsson Foundation and Academy of Finland is gratefully acknowledged.

Date: 2003
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