Examining finite-sample problems in the application of cointegration tests for long-run bilateral exchange rates
AbstractNumerous empirical studies investigate whether exchange rates are related to `economic fundamentals' in the long-run and find a range of relationships through cointegration analysis. We report similar cointegrating relationships for the value of the New Zealand dollar relative to the US dollar (NZD/USD) and for the value of the New Zealand dollar relative to the Australian dollar (NZD/AUD). These include determinants such as commodity prices, 90-day interest rate differentials, and inflation and growth differentials. However, Godbout and van Norden (1997) demonstrate that finite-sample problems may have affected the conclusions of such cointegration studies. Through a simple Monte Carlo study, we consider whether the cointegration coefficients can reasonably be interpreted as `long-run' elasticities of the exchange rate to changes in fundamental variables. The simulation results suggest that given a relatively short span of data it is possible for cointegration analysis to indicate that a long-run relationship has been found when in fact there is only a cyclical relationship. Therefore caution is advised when interpreting the empirical results and making policy assessments about the nature of exchange movements relative to its broad trend.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP 2004/08.
Length: 36 p.
Date of creation: Oct 2004
Date of revision:
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-03-13 (All new papers)
- NEP-ECM-2005-03-13 (Econometrics)
- NEP-ETS-2005-03-13 (Econometric Time Series)
- NEP-IFN-2005-03-13 (International Finance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- James G. MacKinnon, 1995.
"Numerical Distribution Functions for Unit Root and Cointegration Tests,"
Working Papers, Queen's University, Department of Economics
918, Queen's University, Department of Economics.
- MacKinnon, James G, 1996. "Numerical Distribution Functions for Unit Root and Cointegration Tests," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 11(6), pages 601-18, Nov.-Dec..
- Marie-Josée Godbout & Simon van Norden, 1997. "Reconsidering Cointegration in International Finance: Three Case Studies of Size Distortion in Finite Samples," Working Papers, Bank of Canada 97-1, Bank of Canada.
- Gonzalo, Jesus & Lee, Tae-Hwy, 1998.
"Pitfalls in testing for long run relationships,"
Journal of Econometrics, Elsevier,
Elsevier, vol. 86(1), pages 129-154, June.
- Gonzalo, J. & Lee, T.H., 1995. "Pitfalls in Testing for Long Run Relationships," Papers, Boston University - Department of Economics 38, Boston University - Department of Economics.
- DeJong, David N, et al, 1992. "Integration versus Trend Stationarity in Time Series," Econometrica, Econometric Society, Econometric Society, vol. 60(2), pages 423-33, March.
- Niels Haldrup & Michael Jansson, 1999.
"Spurious Regression, Cointegration, and Near Cointegration: A Unifying Approach,"
Tinbergen Institute Discussion Papers, Tinbergen Institute
99-005/4, Tinbergen Institute.
- Jansson, Michael & Haldrup, Niels Prof., 2000. "Spurious Regression, Cointegration, and Near Cointegration: A Unifying Approach," University of California at San Diego, Economics Working Paper Series, Department of Economics, UC San Diego qt5b13w0rp, Department of Economics, UC San Diego.
- Maddala,G. S. & Kim,In-Moo, 1999. "Unit Roots, Cointegration, and Structural Change," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521587822.
- Cheung, Yin-Wong & Chinn, Menzie David, 2001.
"Currency traders and exchange rate dynamics: a survey of the US market,"
Journal of International Money and Finance, Elsevier,
Elsevier, vol. 20(4), pages 439-471, August.
- Yin-Wong Cheung & Menzie D. Chinn, 2000. "Currency Traders and Exchange Rate Dynamics: A Survey of the U.S. Market," CESifo Working Paper Series, CESifo Group Munich 251, CESifo Group Munich.
- Graham Elliott, 1998. "On the Robustness of Cointegration Methods when Regressors Almost Have Unit Roots," Econometrica, Econometric Society, Econometric Society, vol. 66(1), pages 149-158, January.
- Ronald MacDonald, 2002.
"Modelling the Long-run Real Effective Exchange Rate of the New Zealand Dollar,"
Australian Economic Papers, Wiley Blackwell,
Wiley Blackwell, vol. 41(4), pages 519-537, December.
- Ronald MacDonald, 2001. "Modelling the long-run real effective exchange rate of the New Zealand Dollar," Reserve Bank of New Zealand Discussion Paper Series, Reserve Bank of New Zealand DP2002/02, Reserve Bank of New Zealand.
- Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 1(1), pages 19-46, January.
- Anella Munro, 2004. "What drives the New Zealand dollar?," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, Reserve Bank of New Zealand, vol. 67, june.
- James H. Stock & Mark W. Watson, 1991.
"A simple estimator of cointegrating vectors in higher order integrated systems,"
Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago
91-3, Federal Reserve Bank of Chicago.
- Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, Econometric Society, vol. 61(4), pages 783-820, July.
- Chen, Yu-chin & Rogoff, Kenneth, 2003. "Commodity currencies," Journal of International Economics, Elsevier, Elsevier, vol. 60(1), pages 133-160, May.
- Anella Munro, 2005. "UIP, Expectations and the Kiwi," Reserve Bank of New Zealand Discussion Paper Series, Reserve Bank of New Zealand DP2005/05, Reserve Bank of New Zealand.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Reserve Bank of New Zealand Knowledge Centre).
If references are entirely missing, you can add them using this form.