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Can you do the wrong thing and still be right? Hypothesis testing in I(2) and near-I(2) cointegrated VARs

Listed author(s):
  • Francesca Di Iorio
  • Stefano Fachin
  • Riccardo Lucchetti

In this paper, we investigate the small-sample performance of LR tests on long-run coefficients in the I (2) model; we focus on a comparison between I (2) and near- I (2) data, i.e. I (1) data with a second root very close to unity, and report the results of some Monte Carlo experiments. With near- I (2) data, the finite-sample properties of the tests are (i) similar to those found with genuine I (2) data, (ii) systematically superior to those of the analogous tests constructed in the I (1) model, even if the latter is, in principle, correctly specified and the former is not. Therefore, there seems to be strong support to the idea that, in practice, modelling near- I (2) data using the I (2) model may be a good idea, despite the inherent misspecification.

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File URL: http://hdl.handle.net/10.1080/00036846.2016.1142660
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Article provided by Taylor & Francis Journals in its journal Applied Economics.

Volume (Year): 48 (2016)
Issue (Month): 38 (August)
Pages: 3665-3678

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Handle: RePEc:taf:applec:v:48:y:2016:i:38:p:3665-3678
DOI: 10.1080/00036846.2016.1142660
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  1. Serena Ng & Pierre Perron, 2001. "LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power," Econometrica, Econometric Society, vol. 69(6), pages 1519-1554, November.
  2. Luca Fanelli & Emanuele Bacchiocchi, 2005. "Testing the purchasing power parity through I(2) cointegration techniques," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(6), pages 749-770.
  3. Takamitsu Kurita & Heino Bohn Nielsen & Anders Rahbek, 2011. "An I(2) cointegration model with piecewise linear trends," Econometrics Journal, Royal Economic Society, vol. 14(2), pages 131-155, 07.
  4. Hans Christian Kongsted, 2003. "An I(2) cointegration analysis of small-country import price determination," Econometrics Journal, Royal Economic Society, vol. 6(1), pages 53-71, 06.
  5. Johansen, Søren & Juselius, Katarina & Frydman, Roman & Goldberg, Michael, 2010. "Testing hypotheses in an I(2) model with piecewise linear trends. An analysis of the persistent long swings in the Dmk/$ rate," Journal of Econometrics, Elsevier, vol. 158(1), pages 117-129, September.
  6. Paruolo, Paolo & Rahbek, Anders, 1999. "Weak exogeneity in I(2) VAR systems," Journal of Econometrics, Elsevier, vol. 93(2), pages 281-308, December.
  7. Heino Nielsen & Christopher Bowdler, 2006. "Inflation adjustment in the open economy: an I(2) analysis of UK prices," Empirical Economics, Springer, vol. 31(3), pages 569-586, September.
  8. MacKinnon, James G, 1996. "Numerical Distribution Functions for Unit Root and Cointegration Tests," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(6), pages 601-618, Nov.-Dec..
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