The sensitivity of unit root tests to the initial condition and to the lag length selection: A Monte Carlo Simulation Study

While the recent literature has discussed the effect of the deviation of the initial observation of the economic series from its deterministic component (initial condition) on unit root tests, no studies have examined to date the effect of the selection of the lag length on unit root tests in this setting. Our study aims to fill this gap, and provides a recommendation for the practitioner. The objective is to investigate to what extent the sensitivity of the outcome of unit root tests to the initial condition changes with the use of both standard and modified data-dependent methods to select the lag length in the augmented autoregression, even for those tests that have been considered robust in the presence of uncertainty about the initial condition. To do so, we conduct a Monte Carlo simulation study to analyse the finite sample properties (size and power) of unit root tests based on alternative lag selection criteria and different magnitudes of the initial condition.