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A re-examination of the fragility of evidence from cointegration-based tests of foreign exchange market efficiency

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  • John Barkoulas
  • Christopher Baum

Abstract

We re-examine Sephton and Larsen's (1991) conclusion that cointegration-based tests for market efficiency suffer from temporal instability. We improve upon their research by i) including a drift term in the vector error correction model (VECM) in the Johansen procedure, ii) correcting the likelihood ratio test statistic for finite-sample bias, and iii) fitting the model over longer data sets. We show that instability of the Johansen cointegration tests mostly disappears after accounting for these two factors. The evidence is even more stable in favour of no cointegration when we apply our analysis to longer data sets

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File URL: http://www.tandfonline.com/doi/abs/10.1080/758533855
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Bibliographic Info

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

Volume (Year): 7 (1997)
Issue (Month): 6 ()
Pages: 635-643

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Handle: RePEc:taf:apfiec:v:7:y:1997:i:6:p:635-643

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  1. Bossaerts, Peter, 1988. "Common nonstationary components of asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 347-364.
  2. Dwyer, Gerald Jr. & Wallace, Myles S., 1992. "Cointegration and market efficiency," Journal of International Money and Finance, Elsevier, vol. 11(4), pages 318-327, August.
  3. Hakkio, Craig S. & Rush, Mark, 1991. "Cointegration: how short is the long run?," Journal of International Money and Finance, Elsevier, vol. 10(4), pages 571-581, December.
  4. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  5. Craig S. Hakkio & Mark Rush, 1987. "Market efficiency and cointegration," Research Working Paper 87-05, Federal Reserve Bank of Kansas City.
  6. Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
  7. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
  8. Cerchi, Marlene & Havenner, Arthur, 1988. "Cointegration and stock prices : The random walk on wall street revisited," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 333-346.
  9. Sephton, Peter S. & Larsen, Hans K., 1991. "Tests of exchange market efficiency: fragile evidence from cointegration tests," Journal of International Money and Finance, Elsevier, vol. 10(4), pages 561-570, December.
  10. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
  11. Francis X. Diebold & Javier Gardeazabal & Kamil Yilmaz, 1993. "On cointegration and exchange rate dynamics," Working Papers 93-2, Federal Reserve Bank of Philadelphia.
  12. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  13. Baillie, R.T. & Bollerslev, T., 1993. "Cointegration, Fractional Cointegration, and Exchange RAte Dynamics," Papers 9103, Michigan State - Econometrics and Economic Theory.
  14. 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.
  15. Sephton, Peter S, 1994. "Cointegration Tests on MARS," Computational Economics, Society for Computational Economics, vol. 7(1), pages 23-35, February.
  16. Baillie, Richard T & Bollerslev, Tim, 1989. " Common Stochastic Trends in a System of Exchange Rates," Journal of Finance, American Finance Association, vol. 44(1), pages 167-81, March.
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Cited by:
  1. repec:hal:journl:halshs-00193947 is not listed on IDEAS
  2. Jérôme Héricourt & Julien Reynaud, 2006. "La crise monétaire turque de 2000/2001 : analyse de l'échec du plan de stabilisation par le change du FMI," Cahiers de la Maison des Sciences Economiques bla06009, Université Panthéon-Sorbonne (Paris 1).
  3. Eric Zivot, 1998. "Cointegration and Forward and Spot Exchange Rate Regressions," Econometrics 9812001, EconWPA.
  4. Mulligan, Robert F. & Lombardo, Gary A., 2004. "Maritime businesses: volatile stock prices and market valuation inefficiencies," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(2), pages 321-336, May.
  5. David McMillan, 2005. "Cointegrating behaviour between spot and forward exchange rates," Applied Financial Economics, Taylor & Francis Journals, vol. 15(16), pages 1135-1144.
  6. Kühl, Michael, 2010. "Bivariate cointegration of major exchange rates, cross-market efficiency and the introduction of the Euro," Journal of Economics and Business, Elsevier, vol. 62(1), pages 1-19, January.
  7. Heejoon Kang, 1999. "The Applied Cointegration Analysis for the Open Economy: A Critical Review," Open Economies Review, Springer, vol. 10(3), pages 325-346, July.
  8. Zivot, Eric, 2000. "Cointegration and forward and spot exchange rate regressions," Journal of International Money and Finance, Elsevier, vol. 19(6), pages 785-812, December.
  9. Mulligan, Robert F. & Koppl, Roger, 2011. "Monetary policy regimes in macroeconomic data: An application of fractal analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 51(2), pages 201-211, May.
  10. Kühl, Michael, 2007. "Cointegration in the foreign exchange market and market efficiency since the introduction of the Euro: Evidence based on bivariate cointegration analyses," Center for European, Governance and Economic Development Research Discussion Papers 68, University of Goettingen, Department of Economics.
  11. Angela Black & David McMillan, 2004. "Long run trends and volatility spillovers in daily exchange rates," Applied Financial Economics, Taylor & Francis Journals, vol. 14(12), pages 895-907.
  12. Mulligan, Robert F., 2004. "Fractal analysis of highly volatile markets: an application to technology equities," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(1), pages 155-179, February.
  13. Kim, Jeong-Ryeol, 2002. "The stable long-run CAPM and the cross-section of expected returns," Discussion Paper Series 1: Economic Studies 2002,05, Deutsche Bundesbank, Research Centre.

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