School of Economics and Finance

No. 514: A Bayesian Analysis of Unit Roots and Structural Breaks in the Level and the Error Variance of Autoregressive Models

Loukia Meligkotsidou , Lancaster University
Elias Tzavalis , Queen Mary, University of London
Ioannis D. Vrontos , Athens University of Economics and Business

July 1, 2004

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In this paper, a Bayesian approach is suggested to compare unit root models with stationary models when both the level and the error variance are subject to structural changes (known as breaks) of an unknown date. The paper utilizes analytic and Monte Carlo integration techniques for calculating the marginal likelihood of the models under consideration, in order to compute the posterior model probabilities. The performance of the method is assessed by simulation experiments. Some empirical applications of the method are conducted with the aim to investigate if it can detect structural breaks in financial series, with changes in the error variance.

J.E.L classification codes: C11, C22, G10

Keywords:Bayesian inference, Model comparison, Autoregressive models, Unit roots, Structural breaks