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Comparison of Cointegration Tests for Near Integrated Time Series Data with Structural Break

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  • Esin Firuzan
  • Berhan Çoban

Abstract

Sample size of data, presence of structural break, location and magnitude of potential break, and having with near integrated process might affect the performance of cointegration tests. Engle-Granger (EG) and Johansen Cointegration tests may have erroneous results since they do not take into account possible structural break unlike Gregory – Hansen (GH) cointegration test. In this study, it is argued that the suitable choice of cointegration tests is quite complex, since outcomes of these tests are very sensitive to specifying these properties. The performance of cointegration tests is compared to each other underlying properties. This study presents how standard residual based tests- Engle-Granger and Gregory-Hansen- for cointegration can be implemented if series is near integrated, that is close to a unit root process. For assessing the finite sample performance of these tests, a Monte-Carlo experiment showed that both cointegration tests have relatively better size and power properties depend on break point, break magnitude, sample size of time series and the hypothesized value of AR(1) parameter. To illustrate the findings of the paper, a financial data is analyzed. The practitioners should be careful about the hypothesized value of AR(1) parameter which represents dependency degree of the data. If the autoregressive parameters is very close to one and the break magnitude is high, any test is acceptable for moderate to large sample size. However, one might need very large sample size to have a good power and actual size of the test. Additionally, GH test becomes liberal test unlike EG test as the magnitude of structural break increases.

Suggested Citation

  • Esin Firuzan & Berhan Çoban, 2016. "Comparison of Cointegration Tests for Near Integrated Time Series Data with Structural Break," Alphanumeric Journal, Bahadir Fatih Yildirim, vol. 4(1), pages 35-44, June.
    • Handle: RePEc:anm:alpnmr:v:4:y:2016:i:1:p:35-44
    DOI: http://dx.doi.org/10.17093/aj.2016.4.1.5000159943
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    References listed on IDEAS

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    More about this item

    Keywords

    Cointegration; Engle-Granger Cointegration Test; Gregory-Hansen Cointegration Test; Structural Break;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F65 - International Economics - - Economic Impacts of Globalization - - - Finance

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