A finite-sample sensitivity analysis of the Dickey-Fuller test under local-to-unity detrending

Steven Cook

Journal of Applied Statistics, 2006, vol. 33, issue 2, 233-240

Abstract: In recent research, Elliott et al. (1996) have shown the use of local-to-unity detrending via generalized least squares (GLS) to substantially increase the power of the Dickey-Fuller (1979) unit root test. In this paper the relationship between the extent of detrending undertaken, determined by the detrending parameter [image omitted], and the power of the resulting GLS-based Dickey-Fuller (DF-GLS) test is examined. Using Monte Carlo simulation it is shown that the values of [image omitted] suggested by Elliott et al. (1996) on the basis of a limiting power function seldom maximize the power of the DF-GLS test for the finite samples encountered in applied research. This result is found to hold for the DF-GLS test including either an intercept or an intercept and a trend term. An empirical examination of the order of integration of the UK household savings ratio illustrates these findings, with the unit root hypothesis rejected using values of [image omitted] other than that proposed by Elliott et al. (1996).

Keywords: Dickey-Fuller test; unit roots; local-to-unity detrending; savings ratio (search for similar items in EconPapers)
Date: 2006
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DOI: 10.1080/02664760500251725

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