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Regime-Sensitive Cointegration With An Application To Interest-Rate Parity

  • SIKLOS, PIERRE L.
  • GRANGER, CLIVE W.J.

There exist a variety of reasons for the failure to find a uniquecointegrating relationship between economic time series where onewould normally be expected on the basis of economic theory. Amongthese are the testing procedure, the span of the data set, the choiceof lag length in generating the test statistic, the presence ofstructural breaks, and the presence of cointegration only beyond somethreshold. We propose the concept of regime-sensitive cointegrationwhereby the underlying series need not be cointegrated at all times.We show that cointegration can be switched off when a commonstochastic trend is added. Alternatively, cointegration can beswitched on or off because series normally believed to contain a unitactually do not. This implies that a linear combination of suchvariables need not be cointegrated. To illustrate the conceptempirically, we test the hypothesis of interest-rate parity, andrelated hypotheses, using daily Eurorates for the United States andCanada.

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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 1 (1997)
Issue (Month): 03 (September)
Pages: 640-657

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Handle: RePEc:cup:macdyn:v:1:y:1997:i:03:p:640-657_00
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  1. Kasa, Kenneth, 1992. "Common stochastic trends in international stock markets," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 95-124, February.
  2. Perron, P. & Bai, J., 1995. "Estimating and Testing Linear Models with Multiple Structural Changes," Cahiers de recherche 9552, Universite de Montreal, Departement de sciences economiques.
  3. Stock, James H & Watson, Mark W, 1996. "Evidence on Structural Instability in Macroeconomic Time Series Relations," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(1), pages 11-30, January.
  4. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  5. Horvath, Michael T.K. & Watson, Mark W., 1995. "Testing for Cointegration When Some of the Cointegrating Vectors are Prespecified," Econometric Theory, Cambridge University Press, vol. 11(05), pages 984-1014, October.
  6. Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, vol. 57(6), pages 1361-1401, November.
  7. Gregory, Allan W. & Hansen, Bruce E., 1996. "Residual-based tests for cointegration in models with regime shifts," Journal of Econometrics, Elsevier, vol. 70(1), pages 99-126, January.
  8. Brenner, Robin J. & Kroner, Kenneth F., 1995. "Arbitrage, Cointegration, and Testing the Unbiasedness Hypothesis in Financial Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(01), pages 23-42, March.
  9. Jushan Bai & Pierre Perron, 1995. "Estimating & Testing Linear Models with Multiple Structural Changes," Working papers 95-17, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. 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.
  11. Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-26, February.
  12. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164.
  13. Goodwin, Barry K. & Grennes, Thomas J., 1994. "Real interest rate equalization and the integration of international financial markets," Journal of International Money and Finance, Elsevier, vol. 13(1), pages 107-124, February.
  14. Johansen, Soren, 1995. "Likelihood-Based Inference in Cointegrated Vector Autoregressive Models," OUP Catalogue, Oxford University Press, number 9780198774501.
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