Stochastic Permanent Breaks

University of California at San Diego, Department of Economics, Discussion Paper No. 98-03

Posted: 14 Aug 1998

See all articles by Aaron Smith

Aaron Smith

University of California, Davis - Department of Agricultural and Resource Economics

Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: January 1998

Abstract

This paper aims to bridge the gap between processes where shocks are permanent and those with transitory shocks by formulating a process in which the long run impact of each innovation is time varying and stochastic. Frequent transitory shocks are supplemented by occasional permanent shifts. The stochastic permanent breaks (STOPBREAK) process is based on the premise that a shock is more likely to be permanent if it is large than if it is small. This formulation is motivated by a class of processes that undergo random structural breaks. Consistency and asymptotic normality of quasi maximum likelihood estimates is established and locally best hypothesis tests of the null of a random walk are developed. The model is applied to relative prices of pairs of stocks and significant test statistics result.

JEL Classification: C22

Suggested Citation

Smith, Aaron D. and Engle, Robert F., Stochastic Permanent Breaks (January 1998). University of California at San Diego, Department of Economics, Discussion Paper No. 98-03. Available at SSRN: https://ssrn.com/abstract=106049

Aaron D. Smith

University of California, Davis - Department of Agricultural and Resource Economics ( email )

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Robert F. Engle (Contact Author)

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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New York University (NYU) - Department of Finance

Stern School of Business
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National Bureau of Economic Research (NBER)

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