Testing for covariance stationarity in the UK all-equity returns

The paper investigates the proposition that the UK FTSE All-share index returns, during the period from January 2nd, 1970, to October 17th, 1997, are covariance stationary. The null hypothesis of variance constancy is rejected by using the Loretan and Phillips test statistic. An intervention model in the spirit of Box and Tiao is used to filter the effects of the 1973 oil crisis and the 1987 market crash on the variance of the returns. We then apply the Loretan and Phillips test statistic to the residuals from the intervention model. The results suggest that the null hypothesis of constant variance is not rejected, indicating that the initial rejection of the null hypothesis for the original data was due to the oil crisis and market crash. This implies that financial times series can be assumed covariance stationary if properly filtered of the effects of known periods of trouble.