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Testing for Cointegration Using the Johansen Methodology when Variables are Near-Integrated

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Erik Hjalmarsson
Pär Österholm

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Abstract

We investigate the properties of Johansen's (1988, 1991) maximum eigenvalue and trace tests for cointegration under the empirically relevant situation of near-integrated variables. Using Monte Carlo techniques, we show that in a system with near-integrated variables, the probability of reaching an erroneous conclusion regarding the cointegrating rank of the system is generally substantially higher than the nominal size. The risk of concluding that completely unrelated series are cointegrated is therefore non-negligible. The spurious rejection rate can be reduced by performing additional tests of restrictions on the cointegrating vector(s), although it is still substantially larger than the nominal size.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/141.

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Length: 19 pages
Date of creation: 22 Jun 2007
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Handle: RePEc:imf:imfwpa:07/141

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Keywords: Working Paper Financial integration Economic models

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