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TESTING THE ORDER OF FRACTIONAL INTEGRATION OF A TIME SERIES IN THE POSSIBLE PRESENCE OF A TREND BREAK AT AN UNKNOWN POINT

  • Fabrizio Iacone (a1), Stephen J. Leybourne (a2) and A.M. Robert Taylor (a3)
Abstract

We develop a test, based on the Lagrange multiplier [LM] testing principle, for the value of the long memory parameter of a univariate time series that is composed of a fractionally integrated shock around a potentially broken deterministic trend. Our proposed test is constructed from data which are de-trended allowing for a trend break whose (unknown) location is estimated by a standard residual sum of squares estimator applied either to the levels or first differences of the data, depending on the value specified for the long memory parameter under the null hypothesis. We demonstrate that the resulting LM-type statistic has a standard limiting null chi-squared distribution with one degree of freedom, and attains the same asymptotic local power function as an infeasible LM test based on the true shocks. Our proposed test therefore attains the same asymptotic local optimality properties as an oracle LM test in both the trend break and no trend break environments. Moreover, this asymptotic local power function does not alter between the break and no break cases and so there is no loss in asymptotic local power from allowing for a trend break at an unknown point in the sample, even in the case where no break is present. We also report the results from a Monte Carlo study into the finite-sample behaviour of our proposed test.

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Corresponding author
*Address correspondence to Robert Taylor, Essex Business School, University of Essex, Colchester, CO4 3SQ, UK; e-mail: robert.taylor@essex.ac.uk.
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We are grateful to the Editor, Peter Phillips, three anonymous referees and the Co-Editor, Anna Mikusheva, for their very helpful and constructive comments. Taylor gratefully acknowledges financial support provided by the Economic and Social Research Council of the United Kingdom under research grant ES/M01147X/1.

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Econometric Theory
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