What is Unit Root?

A unit root (also called a unit root process or a difference stationary process) is a stochastic trend
in a time series, sometimes called a “random walk with drift”; If a time series has a unit root, it
shows a systematic pattern that is unpredictable.
The Mathematics Behind Unit Roots
The reason why it’s called a unit root is because of the mathematics behind the process. At a
basic level, a process can be written as a series of monomials (expressions with a single term).
Each monomial corresponds to a root. If one of these roots is equal to 1, then that’s a unit root.
The math behind unit roots is beyond the scope of this site (although if you’re really interested
you can read about it in this pdf). All you really need to know if you’re analyzing time series is
that the existence of unit roots can cause your analysis to have serious issues like:
 Spurious regressions: you could get high r-squared values even if the data is
uncorrelated.
 Errant behavior due to assumptions for analysis not being valid. For example, t-ratios
will not follow a t-distribution.
What is a Unit Root Test?
Unit root tests are tests for stationarity in a time series. A time series has stationarity if a shift in
time doesn’t cause a change in the shape of the distribution; unit roots are one cause for non-
stationarity.
These tests are known for having low statistical power. Many tests exist, in part, because none
stand out as having the most power. Tests include:
 The Dickey Fuller Test (sometimes called a Dickey Pantula test), which is based on
linear regression. Serial correlation can be an issue, in which case the Augmented Dickey-
Fuller (ADF) test can be used. The ADF handles bigger, more complex models. It does
have the downside of a fairly high Type I error rate.
 The Elliott–Rothenberg–Stock Test, which has two subtypes:
 The P-test takes the error term’s serial correlation into account,
 The DF-GLS test can be applied to detrended data without intercept.
 The Schmidt–Phillips Test includes the coefficients of the deterministic variables in the
null and alternate hypotheses. Subtypes are the rho-test and the tau-test.
 The Phillips–Perron (PP) Test is a modification of the Dickey Fuller test, and corrects
for autocorrelation and heteroscedasticity in the errors.
 The Zivot-Andrews test allows a break at an unknown point in the intercept or linear
trend.