This paper discusses the type of trajectory a country's public debt path follows. In particular, a Markov switching ADF model is used to assess the sustainability of public debt by testing whether a government's present value borrowing constraint holds. Building on the work of Raybaudi et al. (2004) and Chen (2011), the model in this paper generalizes their methodology. The number of lags and states are in principle unrestricted and all of the parameters can be switching. Debt trajectories of 16 countries are investigated using long time series on debt/GDP obtained from Reinhart and Rogoff (2011). Two different criteria are used to test the null hypothesis of a unit root in each state. The countries with a sustainable debt path are found to be Finland, Norway, Sweden, Switzerland and the UK, while Greece and Japan are found to have unsustainable debt trajectories. The debt paths of the remaining countries are mainly characterized as being in a unit root state and are therefore labeled as uncertain. Robustness tests indicate that the model is robust to the sample size and the number of states used. Further, it is shown that the models used in this paper offer an improvement to existing models investigating this subject.
Examining Board: Professor Helmut Lütkepohl, DIW Berlin and Freie Universität (External Supervisor) Professor Peter Hansen, European University Institute Professor Ralf Brüggemann, University of Konstanz Professor Luca Fanelli, University of Bologna. ; Defence date: 7 June 2013 ; First made available online on 24 September 2013. ; The first paper in this thesis deals with the issue of whether there are bubble components in stock prices. This is joint research with Wenjuan Chen (Free Universtiy Berlin). We investigate existing bivariate structural vector autoregressive (SVAR) models and test their identifying restriction by means of a Markov switching (MS) in heteroskedasticity model. We use data from six different countries and find that, for five of the country models, the structural restriction is supported at the 5% level. Accordingly, we label the two structural shocks as fundamental and non-fundamental. This paper illustrates the virtue of being able to test structural restrictions in order to justify the relevant shocks of interest. The second paper proceeds in the spirit if the first paper. In particular, five trivariate structural VAR or vector error correction (VEC) versions of the dividend discount model are considered, which are widely used in the literature. A common structural parameter identification scheme is used for all these models, which claims to be able to capture fundamental and non-fundamental shocks to stock prices. A MS-SVAR/SVEC model in heteroskedasticity is used to test this identification scheme. It is found that for two of the five models considered, the structural identification scheme appropriately classifies shocks as being either fundamental or non-fundamental. These are models which use real GDP and real dividends as proxies of real economic activity. The findings are supported by a series of robustness tests. Results of this paper serve as a good guideline when conducting future research in this field. The third thesis paper addresses the question of how sustainable a government's current debt path is by means of a Markov switching Augmented Dickey-Fuller (MS-ADF) model. This model is applied to the debt/GDP series of 16 different countries. Stationarity of this series implies that public debt is on a sustainable path and hence, the government's present value borrowing constraint holds. The MS specification also allows for unit root and explosive states of the debt/GDP process. Two different criteria are used to test the null hypothesis of a unit root in each state. The countries with a sustainable debt path are found to be Finland, Norway, Sweden, Switzerland and the UK. The model indicates that France, Greece, Ireland and Japan have unsustainable debt trajectories. The remaining seven countries, (Argentina, Germany, Iceland, Italy, Portugal, Spain and the US) are all found to have uncertain debt paths. The model is robust to the sample size and number of states used. It is shown that this model is an improvement to existing models investigating this subject.
