LM cointegration tests allowing for an unknown number of breaks: implications for the forward rate unbiasedness hypothesis

This article extends the Lagrange multiplier (LM) cointegration test proposed by Westerlund and Edgerton (WE 2007) by allowing for an unknown number of breaks. Monte Carlo simulations provide two main results. First, a loss of power in the LM cointegration tests is detected when potential multiple breaks are ignored. Second, the modified testing procedures do not affect the asymptotic distribution and major properties of the tests of WE under the null, but noticeably increase their testing power in presence of multiple breaks. We also provide empirical applications of the proposed tests for the forward rate unbiasedness hypothesis (FRUH). The results reveal that the FRUH does hold when the effects of the multiple structural breaks are taken into account.