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A new parameters’ encompassing test is proposed for deciding between the deterministic unit root processes with a structural break and the bilinear unit root model without such break. The test consists in testing three sets of hypotheses regarding parameters in a simple regression model. The test uses the t -ratio and F -statistics, of non-trivial distributions under the null hypothesis. The finite sample distributions for the relevant statistics are tabulated and the asymptotic distribution of the F -test is derived. The test has been applied for the daily stock price indices for 66 countries, for the period 1992-2001. The results support the conjecture that the bilinear model dominates the structural break model more often than the other way around. Also, it is likely that in practical applications the bilinear unit root process might be mistaken for the deterministic unit root process with a structural break. Financial support of INTAS project No. 03-51-3714 Nonstationary multivariate and nonlinear econometric models: theory and applications is gratefully acknowledged.

A Simple Encompassing Test for the Deterministic and Bilinear Unit Root Models