A New Bayesian Unit Root Test in Stochastic Volatility Models

Yong Li () and Jun Yu

No 14-2012, Working Papers from Singapore Management University, School of Economics

Abstract: A new posterior odds analysis is proposed to test for a unit root in volatility dynamics in the context of stochastic volatility models. Our analysis extends the Bayesian unit root test of So and Li (1999, Journal of Business and Economic Statistics) in the two important ways. First, a numerically more stable algorithm is introduced to compute Bayes factors, taking into account the special structure of the competing models. Owing to its numerical stability, the algorithm overcomes the problem of the diverging “size” in the marginal likelihood approach. Second, to improve the “power” of the unit root test, a mixed prior specification with random weights is employed. It is shown that the posterior odds ratio is the by-product of Bayesian estimation and can be easily computed by MCMC methods. A simulation study examines the “size” and “power” performances of the new method. An empirical study, based on time series data covering the subprime crisis, reveals some interesting results.

Keywords: Bayes factor; Mixed Prior; Markov Chain Monte Carlo; Posterior odds ratio; Stochastic volatility models; Unit root testing. (search for similar items in EconPapers)
Pages: 26 pages
Date: 2012-01
New Economics Papers: this item is included in nep-ets and nep-ore
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Published in SMU Economics and Statistics Working Paper Series

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Related works:
Working Paper: A New Bayesian Unit Root Test in Stochastic Volatility Models (2010)
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