Abstract
This chapter describes how to deal with the case in which otherwise linear models are subject to one more nonrecurrent, structural breaks. This chapter also builds econometric models with recurrent shifts and nonlinearities caused by regime switching (RS) behavior of threshold type. Section 8.1 explains why these types of models are used, how they can be tested against the time homogenous models analyzed before in the book, and characterizes the sources and nature of the nonlinear dynamics induced by either thresholds or breaks. Section 8.2 specifically deals with linear models that are subject to one or more structural breaks and describes the tests that can be used to detect structural change, when the break dates are known and unknown and need to be estimated along with the nature of the structural shift. Finally, Section 8.3 describes RS models when the instability is driven by threshold effects linked to observable values and smooth transition RS models, when the switching variables just shift the weights dynamically assigned to different regime-dependent portions of an otherwise linear model.
Keywords: Structural breaks; break points; threshold model; smooth transition model; self-exciting threshold autoregression; regime switching
Essentials of Time Series for Financial Applications 