Testing for Parameter Instability and Structural Change in Persistent Predictive Regressions

44 Pages Posted: 14 Apr 2021 Last revised: 26 Jul 2023

See all articles by Torben G. Andersen

Torben G. Andersen

Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); Aarhus University - CREATES

Rasmus Varneskov

Copenhagen Business School

Multiple version iconThere are 2 versions of this paper

Date Written: March 2021

Abstract

This paper develops parameter instability and structural change tests within predictive regressions for economic systems governed by persistent vector autoregressive dynamics. Specifically, in a setting where all – or a subset – of the variables may be fractionally integrated and the predictive relation may feature cointegration, we provide sup-Wald break tests that are constructed using the Local speCtruM (LCM) approach. The new tests cover both parameter variation and multiple structural changes with unknown break dates, and the number of breaks being known or unknown. We establish asymptotic limit theory for the tests, showing that it coincides with standard testing procedures. As a consequence, existing critical values for tied-down Bessel processes may be applied, without modification. We implement the new structural change tests to explore the stability of the fractionally cointegrating relation between implied- and realized volatility (IV and RV). Moreover, we assess the relative efficiency of IV forecasts against a challenging time-series benchmark constructed from high-frequency data. Unlike existing studies, we find evidence that the IV-RV cointegrating relation is unstable, and that carefully constructed time-series forecasts are more efficient than IV in capturing low-frequency movements in RV.

Suggested Citation

Andersen, Torben G. and Varneskov, Rasmus, Testing for Parameter Instability and Structural Change in Persistent Predictive Regressions (March 2021). NBER Working Paper No. w28570, Available at SSRN: https://ssrn.com/abstract=3826052

Torben G. Andersen (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Aarhus University - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Rasmus Varneskov

Copenhagen Business School

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

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