This paper bridges the gap between processes where shocks are permanent and those with transitory shocks by formulating a process in which the long-run impact of each innovation is time-varying and stochastic. In the stochastic permanent breaks (STOPBREAK) process, frequent transitory shocks are supplemented by occasional permanent shifts. Consistency and asymptotic normality of quasi-maximum-likelihood estimates is established, and locally best hypothesis tests of the null of a random walk are developed. The model is applied to relative prices of pairs of stocks and significant test statistics result.

Issue Section:
Symposium on Forecasting and Empirical Methods in Macroeconomics and Finance
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© 1999 President and Fellows of Harvard College and the Massachusetts Institute of Technology
1999
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