Abstract
An implicit assumption in all regression models is that their coefficients remain constant across all observations. When they do not — and this occurs regularly with time series data in particular — the problem of structural change is encountered. After presenting a simulation example of a typical structural break in a regression, methods are introduced to test for such breaks, whether at a known point in time or when the breakpoint is unknown. An approach to modelling changing parameters using dummy variables is introduced and a detailed example of a shifting regression relationship between inflation and interest rates brought about by policy regime changes is presented.
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Notes
Gregory C. Chow, ‘Tests of equality between sets of coefficients in two linear regressions’, Econometrica 28 (1960), 591–605.
These statistics were proposed by R.L. Brown, James Durbin and D.M. Evans, ‘Techniques for testing for the constancy of regression relationships over time’, Journal of the Royal Statistical Society, Series B 37 (1975), 141–192, where expressions for the standard errors associated with the two statistics may be found.
In fact, there is evidence that the interest rate-generating process altered even more frequently over this period, in the earlier years being dependent upon whether Britain was on the gold standard or not. Much more detailed statistical and economic analysis of the historical interaction between inflation and interest rates is provided by Terence C. Mills, ‘Exploring historical economic relationships: two and a half centuries of British interest rates and inflation’, Cliometrica 2 (2008), 213–228,
and Terence C. Mills and Geoffrey E. Wood, ‘Two and a half centuries of British interest rates, monetary regimes and inflation’, in Nicholas Crafts, Terence C. Mills and Geoffrey E. Wood (editors), Explorations in Financial and Monetary History: Essays in Honour of Forrest H. Capie (London, Routledge, 2011), pp. 158–177
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© 2014 Terence C. Mills
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Mills, T.C. (2014). Testing for Stability in Regression Models. In: Analysing Economic Data. Palgrave Texts in Econometrics. Palgrave Macmillan, London. https://doi.org/10.1057/9781137401908_17
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DOI: https://doi.org/10.1057/9781137401908_17
Publisher Name: Palgrave Macmillan, London
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