Political Regimes, Business Cycles, Seasonalities, and Returns
61 Pages Posted: 17 Jun 2006 Last revised: 22 Dec 2008
Date Written: December 17, 2008
This paper provides a method for testing for regime differences when regimes are long-lasting. Standard testing procedures are generally inappropriate because regime persistence causes a spurious regression problem - a problem that has led to incorrect inference in a broad range of studies involving regimes representing political, business, and seasonal cycles. The paper outlines analytically how standard estimators can be adjusted for regime dummy variable persistence. While the adjustments are helpful asymptotically, spurious regression remains a problem in small samples and must be addressed using simulation or bootstrap procedures. We provide a simulation procedure for testing hypotheses in situations where an independent variable in a time-series regression is a persistent regime dummy variable. We also develop a procedure for testing hypotheses in situations where the dependent variable has similar properties.
Keywords: persistent regimes, regime difference tests, spurious regression, dummy variable
JEL Classification: G12, C15, C22
Suggested Citation: Suggested Citation