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Estimating cointegrating vectors using near unit root variables

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  • Aaron Smallwood
  • Stefan Norrbin

Abstract

This paper argues that the predominant method of estimating equilibrium relationships in macroeconometric models, namely the VECM system of Johansen, is severely flawed if the underlying variables are distributed as near unit root processes. Researchers may apply cointegration techniques to these processes, as the power of rejecting near unit roots using standard unit root tests is extremely low. Using Monte Carlo analysis, problematic behaviour of cointegration analysis is found in detecting the true underlying form of the connection between the near unit root processes. Furthermore the connecting vector is imprecisely estimated, resulting in problematic inference for error correction models.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Economics Letters.

Volume (Year): 11 (2004)
Issue (Month): 12 ()
Pages: 781-784

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Handle: RePEc:taf:apeclt:v:11:y:2004:i:12:p:781-784

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  1. Kapetanios, George & Shin, Yongcheol & Snell, Andy, 2003. "Testing for a unit root in the nonlinear STAR framework," Journal of Econometrics, Elsevier, vol. 112(2), pages 359-379, February.
  2. Gonzalo, J. & Lee, T.H., 1995. "Pitfalls in Testing for Long Run Relationships," Papers 38, Boston University - Department of Economics.
  3. D Marinucci & Peter M Robinson, 2001. "Semiparametric Fractional Cointegration Analysis," STICERD - Econometrics Paper Series /2001/420, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  4. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  5. D Marinucci & Peter M. Robinson, 2001. "Semiparametric fractional cointegration analysis," LSE Research Online Documents on Economics 2269, London School of Economics and Political Science, LSE Library.
  6. Francis X. Diebold & Atsushi Inoue, 2000. "Long Memory and Regime Switching," NBER Technical Working Papers 0264, National Bureau of Economic Research, Inc.
  7. n/a, 2001. "Balance of payments prospects in EMU," NIESR Discussion Papers 164, National Institute of Economic and Social Research.
  8. Karim M. Abadir & A. M. Robert Taylor, . "On the Definitions of (Co-)Integration," Discussion Papers 97/19, Department of Economics, University of York.
  9. Cheung, Yin-Wong & Lai, Kon S., 1993. "Long-run purchasing power parity during the recent float," Journal of International Economics, Elsevier, vol. 34(1-2), pages 181-192, February.
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Cited by:
  1. Erik Hjalmarsson & Pär Österholm, 2010. "Testing for cointegration using the Johansen methodology when variables are near-integrated: size distortions and partial remedies," Empirical Economics, Springer, vol. 39(1), pages 51-76, August.
  2. Niko Gobbin & Glenn Rayp, 2008. "Different ways of looking at old issues: a time-series approach to inequality and growth," Applied Economics, Taylor & Francis Journals, vol. 40(7), pages 885-895.

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