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Stationarity and Unit Roots in Time Series: Theoretical Insights and Practical Considerations

S. Sathyanarayana, T. Mohanasundaram
DOI: http://dx.doi.org/10.21013/jmss.v21.n2.p1
Abstract
Time series data plays a central role in econometrics and finance, being the foundation of macroeconomic modelling, financial prediction, and risk assessment. Ensuring stationarity is, however, paramount, as non-stationary series may lead to erroneous statistical inference and spurious regressions. This essay discusses the problem of unit roots and stationarity, and gives a thorough description of different unit root tests. It starts with the old ones like the Dickey-Fuller test and Phillips-Perron (PP) test, and then proceeds to the newer ones, like the KPSS test, which is a stationarity test, not a test of unit roots. Structural tests such as Zivot-Andrews and panel unit root tests can also be employed. The research uses these tests to an empirical data set of macroeconomic variables and financial time series, assessing whether the series are stationary or need to be transformed. Empirical results underscore the significance of stationarity in Vector Autoregression (VAR), Cointegration Analysis, and forecasting models like ARIMA and GARCH. The findings indicate the relevance of proper unit root testing in economic and financial modelling to ensure firm policy choices and solid investment choices. The paper also explores methodological difficulties, such as small-sample bias, structural changes, and nonlinearity. Nonlinear unit root tests and machine learning strategies should be pursued in future work to enhance prediction accuracy.
Keywords
Stationarity, Unit Root, VAR framework, GARCH, Panel Data, Time Series
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