Economics Letters 38 (1992) 381-386 381

North-Holland

Testing for unit roots using

the augmented Dickey-Fuller test
Some issues relating to the size, power and the lag
structure of the test
R.I.D. Harris
Unimrsity of Waikato, Hamilton, New Zealand

Received 15 October 1991

Accepted 29 January 1992

The main purpose is to consider some of the operational aspects of the ADF test, and especially the question of how many
autoregressive lags are needed to capture the underlying d.g.p. when the latter may be a mixed ARIMA process. Thus the
results from Monte-Carlo experiments (using various stochastic processes) are reported to determine the lag structure and
whether the ADF test consistently rejects the null and alternative when it is true.

1. Introduction

A univariate test for the presence of a unit root (and thus non-stationarity) that is becoming
quite common (cf. the regression packages SHAZAM 6.1 and TSP 4.2) is the augmented Dickey-
Fuller test (ADF). The main purpose of this letter is to consider some of the operational aspects of
this test, and especially the question of how many autoregressive lags are needed to capture the
underlying d.g.p. when the latter may be a mixed ARIMA process. Thus the results from
Monte-Carlo experiments (using various stochastic processes) are reported in section 3 to deter-
mine the lag structure and whether the ADF test consistently rejects the null and alternative when
it is true. Concluding comments are presented in section 4.

2. Unit root tests

A number of tests for a unit root have been proposed, with the most popular being the Sargan
and Bhargava (1983) CRDW test, the Dickey-Fuller (DF) test, the augmented Dickey-Fuller
(ADF) test, and the test developed by Phillips and Perron based on the Phillips (1987) Z test. ’ The

Correspondence to: Dr. Richard I.D. Harris, Department of Economics, University of Waikato, Private Bag, Hamilton, New
Zealand.
’ See Phillips and Perron (1988); Perron (1988).
’ Note, it is invariant to whether a trend enters into the true model, which is not the case for the DF and ADF tests.

01651765/92/$05.00 0 1992 Elsevier Science Publishers B.V. All rights reserved

382 R.I. D. Harris / Testing for unit roots

CRDW test is the uniformly most powerful invariant test against the alternative of a stationary
first-order autoregressive error process. 2. Therefore, it lacks generality since the other tests noted
above are not confined to testing the null against a first-order autoregressive process. However,
with the DF and ADF tests the presence of serial correlation will affect the distributions of the test
statistics and therefore invalidate the tests. The solution favoured by Dickey and Fuller (1981) is to
add a distributed lag of the (first-differenced) variable under consideration:

AY,=c.uY,-,+ CP, &-,+6+yt+u,, (1)

j= 1

in order to capture any serial correlation. This introduces the problem that an unknown number of
lags may be needed, as well as the fact that the underlying processes generating a variable may not
be autoregressive. However, Said and Dickey (1984) have shown that a high-order autoregressive
process, AR(p), can be used to approximate an unknown ARIMA process, in which the order of
the autoregression grows with sample size.
For the ADF test the presence (or otherwise) of drift and/or trend necessitates that if the null
hypothesis of a unit root (H, : cy = 0) is not rejected [using Fuller’s (1976) +, distribution of the
t-statistic of &), then it is necessary to proceed to test the joint hypothesis that a = 0 and y = 0
(using the F-statistic QX given in Dickey and Fuller (198111. As Dolado, Jenkinson and Sosvilla-
River0 (1990) point out, if the trend is significant under the null of a unit root, then normality of
the t-statistic of G follows, and the standardised normal tables should be used. If the trend is not
significant, the nuIl is then tested with the constraint that y = 0 [using ?, from Fuller (197611.
Again, failure to reject means testing the joint hypothesis that cz = 0 and 6 = 0 [this time using the
F-statistic @i given in Dickey and Fuller (198l)l. If the constant under the null hypothesis is
significant, then the test for the unit root should be repeated using the standardised normal;
otherwise, Fuller’s 7^ should be used.
When using the ADF test, the fact that the underlying d.g.p. is unknown means that some
practical means of choosing T must be invoked. Said and Dickey (1984) point out that while they
are able to show that with an ARIMA process the order of autoregression grows with sample size
n, ‘... the limit theory, of course, does not specify the value of (p) for any given IZ’ (p. 606).
Schwert (1989) used p = 4 and p = 12 for a sample size of 100. ’ A more formal approach that has
been used is to choose the value of p that minimises Akaike’s (1973) Information Criterion, which
with Gaussian errors amounts to maximising R*. As Harvey (1981) points out: ‘the emphasis is on
comparing the “goodness of fit” of various models with an appropriate allowance made for
parsimony. This has a good deal of appeal in problems where the specification is based primarily on
pragmatic considerations’ (p. 176). In the current situation, parsimony may be especially important,
given that the critical values of the various t-statistics depend upon the ‘nuisance’ parameters
contained in the model and in the d.g.p. Thus, p was chosen here on the basis of maximising R*
(for comparison, the results are reported for when other values of p are used).

3. Monte-Carlo experiments

The experiments undertaken comprised constructing data using three basic d.g.p.‘s (ARMA, AR
and MA), with each also allowing for the presence (or otherwise) of drift and/or trend. The

’ For other values of n he used lag lengths based on: I, = int(4(n /100)‘/4} and I,, = int(l2(n /100)‘/4) so, for example,
when n = 25, p works out to be equal to 2 and 8. The rationale for using this approach is that the order of the
autoregression grows with the sample size n.
 R.I. D. Harris / Testing for unit roots 383

autoregressive part of the d.g.p., when included, was simply (0.5 Ay,_ , + 0.2 A y, _*I. The moving
average component was defined as (u, + 0.8u,_ ,>, where the CL, are serially uncorrelated standard
normal variables. When included, the constant took on a value of 1, and the time trend was defined
as (t - (n + 1)/2). The data were generated by setting U_~~ and y_,” equal to 0 and creating
II + 20 observations, and discarding the first 20 observations. Sample sizes of n = 50, 100 were used,
and for each model, the length of p chosen was based on the highest average value of R2 obtained
over the range p = 0,. . ,25. 4 Then each model was replicated 2,000 times to create the sampling
distributions for the test statistics,
The results for each basic d.g.p. are given in table 1. For each model, results are presented for
the three versions of the ADF test with drift and/or trend (only results for II = 50 are presented;
the results for II = 100 are not very different, and are available on request). Reading across the top
of the table, II refers to sample size; p (s.d.p) denotes the average lag length obtained (and
associated standard deviation); ? refers to either i,, +, or ? depending the ADF test is carried out
with y # 0 and 6 # 0, or y = 0 and 6 # 0, or y = 0 and 6 = 0; @ refers to Q1 or Q1, depending on
whether the joint hypothesis (Y= y = 0 or (Y= S = 0 is being tested; and t refers to the standard
t-statistic. For +, @, and t the results in the table show the percentage of times the null of
non-stationarity was rejected when it is true [based on the 5% critical values in Fuller (1976),
Dickey and Fuller (1981), and the Student’s t distribution]. Lastly, the final three columns in table
1 refer to the ? distribution of the t-statistic of & when the lag length is fixed by reference to the
formula li = int{i(n/100)‘/4) as set out in footnote 4.
Maximising R2 to choose the value of p in the ADF test proves unsatisfactory. In most cases,
the standard deviation of p is high, which has an adverse effect on the size of the test. There are
several instances when ? has a large value while ?,(12) is relatively small, even though on average p
is large. Inclusion of drift and/or trend terms into the test, when the d.g.p. lacks these components,
quite often results in the size of the test being far from its nominal value. Again, this may be related
to the apparent instability of the method for choosing p, since size was closer to its nominal value
when the lag length was pre-chosen to obtain e1(,2).
In general, and on the basis of the size of the test, the results for +,(,,, are generally superior. ’
Thus the power of the ADF test based on i,(,,, was computed for -0.2 G (YQ 0. The results for
each d.g.p. and the relevant form of the ADF test [i.e. if the model included drift and/or trend, the
corresponding version of eq. (1) was used] are reported in table 2. These indicate the percentage of
times the null hypothesis of non-stationarity was rejected when the alternative is true [based on the
5% critical values of the null given by Fuller (1976)]. As can be seen, the power properties of the
ADF test are generally acceptable for the models tested here.

4. Conclusions

There are outstanding issues, relating to the appropriate lag structure for the ADF test, that
remain to be tackled. This letter has shown that the correct size of the test is consistently achieved
when p is chosen on the basis of Akaike’s (1973) Information Criterion, but that choosing a fairly
generous value of p (e.g. by using a formula that allows the order of autoregression to grow with
sample size n) can result in a test with size close to its nominal value, and with adequate power.
However, this rather ad hoc use of the ADF test when the underlying d.g.p. is unknown is not

’ In total, 54 models were estimated, with each involving 26 regressions in order to cover the range of lag structures used.
5 The full set of results using i,(,,, to test the null are available in an unpublished appendix, available from the author.
These confirm that for the models tested here, the size properties of the ADF test using i,,,,, are generally acceptable.
384 R.I.D. Harris / Testing for unit roots

Table 1
Results of Monte-Carlo experiments relating to the size of the ADF test

Model & n p (s.d.p) ; @

ADF test used
(i)Ay,=l+(t-(n+1)/2)+0.5Ay,+,+0.2 Ay,_2+~,-0.8u,m,

(a)y#O&S#O 50 13 (8.8) 1.0 64.9 11.9 0.0 0.0 0.1

(b)y=O&cY#O 50 18 (5.5) 1.0 82.2 13.2 100.0 0.0 0.1
(c)y=O&cY=O 50 20 (3.4) 6.5 _ _ 0.0 100.0 0.0

(ii)Ay,=1+0.5Ay,+,+O.2Ay,+,+u,-O.Su,+,

(a)y+0&6+0 50 11 (8.6) 17.2 18.4 75.5 28.7 4.8 2.1

(b)y=O&6#0 50 10 (8.0) 1.5 69.5 10.2 0.0 0.1 0.9
(c)y=O&cY=O 50 9 (9.0) 1.9 _ _ 0.0 0.0 0.0

(iii)AyI=0.5Ay,_,+0.2Ay,+,+u,-0.8u,+1

(a)y#0&6#0 50 11 (8.8) 19.1 20.7 78.1 27.0 4.7 3.4

(b)y=O&S#O 50 9 (8.1) 11.1 13.2 53.1 18.7 4.0 3.9
(c)y=O&iS=O 50 9 (7.9) 8.6 _ _ 13.7 6.8 4.8

(iv)Ay,=l+(f-(n+1)/2)+0.5Ay,+,+0.2 Ayrm2+u,

(a)y+0&6+0 50 14 (8.6) 2.9 48.3 19.5 4.2 0.6 0.5

(b)y=O& 650 50 14 (8.0) 2.5 81.5 13.5 97.1 0.0 1.5
k)y=O&cY=O 50 13 (8.5) 41.0 _ _ 0.0 100.0 6.8

(v)A~,=~+O.~A~~~,+O.~A~,_~+U,

(a)y+0&6#0 50 12 (8.5) 21.0 25.2 73.1 1.4 4.7 5.7

(b)y=O&S#O 50 11 (8.3) 4.0 50.9 19.7 9.9 0.8 1.9
(c)y=O&6=0 50 10 (7.5) 1.8 _ 0.0 0.0 0.0

(vi) Ay, = 0.5 Ay,-, +0.2 Ay,_, + u,

(a)y#O&S+O 50 12 (8.4) 18.1 23.0 72.1 4.6 5.2 3.7

(b)y=0&6#0 50 10 (8.1) 12.9 16.7 48.8 5.8 4.8 5.4
(c)y=O&cY=O 50 9 (7.6) 9.7 _ _ 0.0 5.0 4.7

(vii) Ay, = 1 +(t -(n + 1)/2)+ u, -0.8~~~~

(a)y#O&6#0 50 14 (6.9) 1.2 58.0 12.0 0.0 0.0 0.1

(b)y=O&cS+O 50 17 (4.9) 0.1 82.6 2.5 0.0 0.0 0.0
(c)y=O&6=0 50 19 (4.2) 2.2 _ 0.0 100.0 36.0

(viii) Ay, = 1+ u, - 0.8~~ _ ,

(a)y+O&S#O 50 10 (8.9) 41.1 40.8 85.4 100.0 35.3 2.9

(b)y=O& 6fO 50 13 (6.9) 0.7 71.0 8.4 0.0 0.0 0.4
(c)y=O&6=0 50 17 (5.4) 0.3 _ _ 0.0 0.0 0.0

(ix) Ay, = u, -0.8~4~~

(a)y#O&6#0 50 10 (8.6) 40.4 39.1 85.4 99.8 30.2 3.7

(b)y=O&cY+O 50 9 (8.1) 30.0 29.0 62.3 99.2 29.2 3.9
(c)y=O&6=0 50 11 (7.0) 7.2 _ _ 72.7 16.7 3.9

a See text for details.

 R. I. D. Harris / Testing for unit roots 385

Table 2
Results of Monte-Carlo experiments relating to the power of the ADF test with lag length based on I,, = int(12(n/100)“4}.

Model Value of (Y
- 0.20 - 0.18 -0.16 -0.14 -0.12 -0.10 -0.08 -0.06 -0.04 -0.02 -0.00

ARMA(y#O&6+0)

(a) n = 50 43.2 48.5 54.3 50.4 52.5 52.7 56.1 57.8 48.6 56.7 0.1
(b) n = 100 91.9 89.8 92.7 95.1 93.5 94.9 95.0 93.7 93.4 94.7 0.0

ARMA(y=O&GIO)

(a) n = 50 48.5 30.2 34.2 24.6 31.9 14.5 11.4 14.4 10.8 23.4 0.9
(b) n = 100 79.9 77.3 74.0 69.6 63.6 61.3 51.8 54.8 36.8 67.1 0.6

ARMA(y=O&S=O)

(a) n = 50 78.6 78.1 85.7 64.7 70.9 68.6 67.5 38.2 21.5 31.9 0.0
(b) n = 100 99.1 99.4 97.9 97.8 99.9 93.6 89.8 84.3 71.3 31.5 4.6

AR(y#O&S+O)

(a) n = 50 11.7 13.1 13.5 18.8 16.0 17.1 21.2 23.6 20.8 21.0 0.5
(b) n = 100 38.1 36.9 38.1 35.2 37.8 39.3 34.4 47.9 47.3 50.1 0.0

AR(y=O&fi#O)

(a) n = 50 23.8 21 .o 10.6 9.1 10.2 15.6 7.2 6.7 8.0 10.1 1.9
(b) n = 100 47.7 49.1 37.0 31.6 28.1 28.2 25.3 32.8 20.7 17.5 2.6

AR(y=O&S=O)

(a) n = 50 43.5 40.0 43.6 36.7 30.5 73.5 46.1 32.4 17.9 20.6 4.7
(b) n = 100 88.1 82.5 80.8 86.8 75.4 76.4 60.9 65.1 54.6 22.6 4.0

MA(y+O&SfO)

(a) n = 50 35.7 39.0 37.0 37.7 38.6 34.2 36.7 41.2 47.6 52.1 0.1
(b) n = 100 87.0 85.4 85.9 86.9 86.6 88.0 85.7 88.9 91.0 88.1 0.0

MA(y=O&6#0)

(a) n = 50 12.4 12.3 14.5 11.5 16.9 19.5 17.3 12.6 35.0 47.4 0.4
(b) n = 100 50.3 37.6 40.7 72.9 47.7 57.5 82.9 57.6 98.6 87.3 0.3

MA(y=O&6=0)

(a) n = 50 55.2 42.2 35.5 33.5 31.4 50.6 19.7 19.3 11.1 11.6 3.9
(b) n = 100 88.4 85.8 77.3 76.5 67.6 59.8 49.5 39.0 43.0 15.5 6.6

satisfactory; it remains to be seen how robust the test is using other d.g.p.‘s and/or more
appropriate methods of choosing p need to be considered.

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