Nonstationary Binary Choice

Peter Phillips and Joon Park

No 1223, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: This paper develops an asymptotic theory for time series binary choice models with nonstationary explanatory variables generated as integrated processes. Both logit and probit models are covered. The maximum likelihood (ML) estimator is consistent but a new phenomenon arises in its limit distribution theory. The estimator consists of a mixture of two components, one of which is parallel to and the other orthogonal to the direction of the true parameter vector, with the latter being the principal component. The ML estimator is shown to converge at a rate of n^{3/4} along its principal component but has the slower rate of n^{1/4} convergence in all other directions. This is the first instance known to the authors of multiple convergence rates in models where the regressors have the same (full rank) stochastic order and where the parameters appear in linear forms of these regressors. It is a consequence of the fact that the estimating equations involve nonlinear integrable transformations of linear forms of integrated processes as well as polynomials in these processes, and the asymptotic behavior of these elements are quite different. The limit distribution of the ML estimator is derived and is shown to be a mixture of two mixed normal distributions with mixing variates that are dependent upon Brownian local time as well as Brownian motion. It is further shown that the sample proportion of binary choices follows an arc sine law and therefore spends most of its time in the neighbourhood of zero or unity. The result has implications for policy decision making that involves binary choices and where the decisions depend on economic fundamentals that involve stochastic trends. Our limit theory shows that, in such conditions, policy is likely to manifest streams of little intervention or intensive intervention.

Keywords: Binary choice model; Brownian motion; Brownian local time; dual convergence rates; Integrated time series; maximum likelihood estimation (search for similar items in EconPapers)
JEL-codes: C22 C25 (search for similar items in EconPapers)
Pages: 35 pages
Date: 1999-06
Note: CFP 1003.
References: View references in EconPapers View complete reference list from CitEc
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Published in Econometrica (September 2000), 68(5): 1249-1280

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