Unit Root Tests in the Presence of Markov Regime-Switching

We investigate the performance of a battery of standard unit root tests when the true data generating process has a Markov-switching trend growth rate and variance. Regime switching under both the null hypothesis of a unit root and the alternative hypothesis of trend stationarity is considered. In contrast to the case of a single break in trend growth rate, multiple Markov-switching breaks under the null hypothesis do not create size distortions in the Augmented Dickey-Fuller test. Markov-switching in variance under the null hypothesis does not adversely affect standard unit root tests but can lead to overrejection in tests which allow for structural change. All tests have very low power when regime switching occurs under an alternative hypothesis which is stationary in the periods between the switching.