The Power of the “Objective” Bayesian Unit-Root Test

ABSTRACT

Some researchers, for example, Koop [1], and Sims [2], have advocated for Bayesian alternatives to unit-root testing over the classical approach using the augmented Dickey-Fuller test (ADF). This paper studies the power of what Koop [1] has called the “Objective” Bayesian approach to unit-root testing. Koop’s “objective” Bayesian test is interesting in light of the call by Phillips [3, 4] for more objective Bayesian analysis of time series. We apply the “objective” Bayesian unit-root test to a study of long-run purchasing power parity (PPP) in the post-Bretton Woods era and also Monte Carlo simulations. Overall, contrary to the favorable simulation results obtained by Koop [1], our results suggest that the “objective” Bayesian test is biased in favor of trend-stationarity. We conclude that, at least for the “objective” Bayesian test, it is not better than the classical ADF approach in unit-root tests, and because of its bias, the “objective” priors suggested by Koop [1] is not appropriate, and we do not recommend its use.

JEL Classification: C11, C22, F31.

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