A Specification Search Algorithm for Cointegrated Systems

A specification search algorithm is proposed that aims to assist the user in the process of constructing Vector Error Correction Models. The algorithm automates testing the cointegration rank of the system and performs simplifications based on possible weak exogeneity of some variables. Overidentification restrictions can be provided by the user or can be imposed by an expert system that is a part of the algorithm. That expert system is not general, but is specific to the analysed problem. As an illustration we present an expert system for money demand specifications - it attempts to impose various restrictions typically used in money demand studies. Combinations of individual restrictions are jointly tested by a procedure similar to Omtzigt's algorithm. The algorithm is evaluated in a series of Monte-Carlo experiments. Preliminary results show that algorithm works quite well, and the true data generation processes are often recovered by the algorithm. As an empirical illustration, an automated construction of money demand systems for Germany and Switzerland is presented. Results are compared with some earlier work on money demand for these countries. In both cases stable money demand functions are found, however specifications differ from those obtained by the original authors