LSTUR regression theory and the instability of the sample correlation coefficient between financial return indices. Issue 1 (26th May 2020)

• Record Type: Journal Article
• Authors: Ginker, Tim; Lieberman, Offer
• Is Part Of: Econometrics journal. Volume 24:Issue 1(2021)
• Page Start: 58
• Page End: 82
• Publication Date: 2020-05-26
• Subjects: Autoregression -- stochastic unit root -- spurious regression -- time-varying coefficients; Econometrics -- Periodicals; 330.015195
• DOI: 10.1093/ectj/utaa011
• Languages: English
• ISSNs: 1368-4221

Abstract

Summary: It is well known that the sample correlation coefficient between many financial return indices exhibits substantial variation on any reasonable sampling window. This stylised fact contradicts a unit root model for the underlying processes in levels, as the statistic converges in probability to a constant under this modeling scheme. In this paper, we establish asymptotic theory for regression in local stochastic unit root (LSTUR) variables. An empirical application reveals that the new theory explains very well the instability, in both sign and scale, of the sample correlation coefficient between gold, oil, and stock return price indices. In addition, we establish spurious regression theory for LSTUR variables, which generalises the results known hitherto, as well as a theory for balanced regression in this setting.