Exploiting infinite variance through dummy variables in nonstationary autoregressions

We consider estimation and testing in finite-order autoregressive models with a (near) unit root and infinite-variance innovations. We study the asymptotic properties of estimators obtained by dummying out large innovations, i.e., those exceeding a given threshold. These estimators reflect the common practice of dealing with large residuals by including impulse dummies in the estimated regression. Iterative versions of the dummy-variable estimator are also discussed. We provide conditions on the preliminary parameter estimator and on the threshold that ensure that (i) the dummy-based estimator is consistent at higher rates than the ordinary least squares estimator, (ii) an asymptotically normal test statistic for the unit root hypothesis can be derived, and (iii) order of magnitude gains of local power are obtained.