Prof. Douglas Steigerwald (UCSB Economics Department)

Title: SUBSAMPLE TESTS FOR REGIME SWITCHING

Abstract: Models of regime switching do not satisfy the standard assumptions that govern the large sample behavior of test statistics. Research focuses on likelihood ratio tests and the most recent advances, due to Cho and White (2007), yield a limit distribution for the likelihood ratio test that depends on specified intervals for the coefficients that vary over regimes. As the limit distribution is not standard, Cho and White obtain critical values from a numeric approximation that requires explicit specification of these coefficient intervals. As researchers may lack knowledge of the correct coefficient interval, we study how misspecification of the interval impacts numerically approximated critical values and the resultant power of likelihood ratio tests. We find that the power of likelihood ratio tests is sensitive to the coefficient interval specified in the numeric approximation from Cho and White. To eliminate power losses that arise from coefficient interval misspecification we use subsamples, which do not require explicit specification of the coefficient interval. We compare the likelihood ratio test, based on subsampled critical values, with two other tests and find large size-adjusted power gains for the likelihood ratio test. (Joint work between Prof Douglas Steigerwald and Benjamin Hansen)