EXAMPLE FTA UNIT ROOT TESTS

This small guide shows you how to recreate the results for the example used in class. For the corresponding
graphs and tables see the sheets/handouts on this topic. I used EViews5.

The following steps are deliberately kept easy, using the EViews point-and-click approach. However, I assume
you have familiarized yourself with the operation of EViews and understand the various routes one can take to
obtain the results described below.
There is an EViews program (list of commands executed automatically) associated with this example that shows
you how to use the appropriate command statements and do some programming.

START EVIEWS

Select Menu options File/Open/EViewsWorkfile

Select the existing workfile FTA.wf1 from the directory where you saved it.
The workfile contains the time series data for the FT-All Share price index, FT-All Share dividend index, yield
on 20 year UK government bonds (Gilts), rate on 91 day UK Treasury bills. Monthly observations, January 1965
(1965:01 or 1965M01) to December 1995 (1995:12 or 1995M12).

DATA TRANSFORMATIONS
Additional series from data transformations are created in the command window at the top as
smpl @all ‘ reset the sample period for calculations to the total sample used in the workfile
‘ use all available observations
series lprice = log(ftaprice) ‘ create (natural) log version of the variable

UNIT ROOT TESTS

Select the series lnftaprice
Set the sample period. In this case use the full sample period: smpl @all. Note that EViews will adjust the
sample for the lags used in the unit root tests. If you want/need to avoid this, think about where the correct
sample period should start and set the smpl command accordingly.
Select View/Unit Root Test,
Select the desired test: ADF, PP, KPSS (or one of the other methods, which we will not discuss)
Test for unit root in level
Select the desired options on inclusion/exclusion of constant term and trend variable
Select the option on lag length determination: AIC, SIC, HIC, or set the lags to some predetermined value
Note: For PP and KPSS test statistics, we do not go into details about the selection of Spectral estimation and
Bandwith selection methods. Rely on the EViews default settings for these tests.

Normally the unit root tests are performed for levels, 1st differences, 2nd differences of the variables. If we cannot
reject a unit root in levels, but do reject a unit root in 1st differences the variable in levels is called I(1), i.e.
needing one time differencing to become stationary. The series in first-differences is stationary and called I(0). If
we cannot reject a unit root in 1st differences, but do reject a unit root in 2nd differences the variable in levels is
called I(2), i.e. needing two times differencing to become stationary.
Do we reject the null hypothesis of a unit root (ADF, PP) or null hypothesis of stationarity in the case of the
KPSS test? Look up the correct test-statistic and compare its value to the EViews reported critical values and/or
look up the corresponding probability value to determine the significance level.

Repeat the procedure for other variables

ldiv = log(ftadiv)
r20
rs