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Federal Reserve Bank of St. Louis
Working Papers
A time-varying threshold STAR model of unemployment and the natural rate
Michael J. Dueker
Michael T. Owyang
Martin Sola
Abstract

Smooth-transition autoregressive (STAR) models have proven to be worthy competitors of Markov-switching models of regime shifts, but the assumption of a time-invariant threshold level does not seem realistic and it holds back this class of models from reaching their potential usefulness. Indeed, an estimate of a time-varying threshold level of unemployment, for example, might serve as a meaningful estimate of the natural rate of unemployment. More precisely, within a STAR framework, one might call the time-varying threshold the “tipping level” rate of unemployment, at which the mean and dynamics of the unemployment rate shift. In addition, once the threshold level is allowed to be time-varying, one can add an error-correction term—between the lagged level of unemployment and the lagged threshold level—to the autoregressive terms in the STAR model. In this way, the time-varying latent threshold level serves dual roles: as a demarcation between regimes and as part of an error-correction term.free rate puzzles, and the occurrence of trading break-downs.


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Michael J. Dueker & Michael T. Owyang & Martin Sola, A time-varying threshold STAR model of unemployment and the natural rate, Federal Reserve Bank of St. Louis, Working Papers 2010-029, 2010.
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Keywords: Time-series analysis ; Capital assets pricing model ; Unemployment
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