Essays on business cycle asymmetry

The dissertation is comprised of three chapters, each investigating Markov-switching models of U.S. business cycle asymmetry. In the first essay, I investigate the performance of a battery of unit root tests in the presence of Markov-switching in trend growth rate and variance, a model commonly used to capture business cycle non-linearities. In contrast to the case of a single break in trend growth rate, multiple Markov-switching breaks under the null hypothesis do not cause size distortions in the Augmented Dickey-Fuller test. Markov-switching in variance under the null hypothesis does not adversely affect standard unit root tests but can lead to over-rejection in tests allowing for a single structural break in the level of trend. All tests, including those robust to a single episode of structural change under the alternative, have very low power when regime switching occurs under an otherwise stationary alternative. In the second and third essays, I investigate the nature of U.S. business cycle asymmetry using a cointegrated, Markov-switching, dynamic factor model of output, investment, and consumption that imbeds the permanent income hypothesis within a simple growth model The second essay characterizes and tests for two types of commonly identified asymmetry: (1) Infrequent negative permanent shocks, modeled as shifts in the growth rate of the common stochastic trend and (2) Infrequent negative transitory shocks, modeled as "plucking" deviations from the common stochastic trend. Tests of marginal significance suggest both types of asymmetry were present in post-war recessions, although the shifts in trend are less severe than the received literature suggests. In the third essay I characterize the contemporaneous and lead-lag relationship between the trend and transitory types of asymmetry discussed in the second essay using a four state Markov-switching model. I find that a model that allows for such correlation is preferred to a model that assumes independence. In particular, the parameter estimates suggest a specific pattern for recessions: Shifts in trend growth rate lead both the appearance of asymmetry in the transitory component when entering recessions and its disappearance when leaving recessions.