Bubble testing under polynomial trends

Xiaohu Wang and Jun Yu

The Econometrics Journal, 2023, vol. 26, issue 1, 25-44

Abstract: SummaryThis paper develops the asymptotic theory of the least squares estimator of the autoregressive (AR) coefficient in an AR(1) regression with intercept when data is generated from a polynomial trend model in different forms. It is shown that the commonly used right-tailed unit root tests tend to favour the explosive alternative. A new procedure, which implements the right-tailed unit root tests in an AR(2) regression, is proposed. It is shown that, when the data generating process has a polynomial trend, the test statistics based on the new procedure cannot find evidence of explosiveness. Whereas, when the data generating process is mildly explosive, the new procedure finds evidence of explosiveness. Hence, it enables robust bubble testing under polynomial trends. Empirical application of the proposed procedure using data from the US real estate market reveals some interesting findings. In particular, all the negative bubble episodes flagged by the traditional method are no longer regarded as bubbles by the new procedure.

Keywords: Autoregressive regressions; right-tailed unit root test; mildly explosive processes; polynomial trends; coefficient-based statistic; t statistic (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:oup:emjrnl:v:26:y:2023:i:1:p:25-44.

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