Non-linear error correction, asymmetric adjustment and cointegration
This paper has three main components. First, it outlines a model of nonlinear error correction (NEC) in which the linear error correction term a'Xt (the vector time series Xt is cointegrated, a is the cointegrating vector) is replaced by the nonlinear term g(a'X),ˇ where g(.) is a nonlinear function. Second, several types of asymmetries are discussed. The NEC model is shown to have an underlying structural model in the form of an adjustment cost model, with asymmetric adjustment costs. The implications for the NEC model of trending targets are explained. Third, it is shown that nonlinear error correction is present in a trivariate series of UK employment, wage, and capital stock.
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