ECON301_Handout_12_1213_02

# A cusum and cusumsq tests we may have no strong prior

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A. CUSUM and CUSUMSQ tests We may have no strong prior knowledge of specific structural breaks. Another method used to avoid arbitrary breakpoints (structural change points) is based on recursive estimation . This involves estimating the equation by OLS; starting with a small sample and allow the data period to increase by one period each estimate. It therefore produces a time series of estimates for the coefficients. These can be plotted with confidence intervals. Under the null hypothesis of parameter stability CUSUM should have zero mean and variance approximately equal to the number of normalised residuals being summed. Reject the null hypothesis of parameter stability if the CUSUM plot cross's any of the two lines. 5

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