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Permanent and transitory components of GDP and stock prices: further analysis

  • Jesus Gonzalo

    ()

  • Tae-Hwy Lee

    ()

  • Weiping Yang

    ()

Using the conventional VAR identification approach, Cochrane (1994) finds that substantial amounts of variation in GDP growth and stock returns are due to transitory shocks. Following the common trend decomposition of King, et al. (1991), we show that Cochrane's results depend on the assumption of weak exogeneity of one of the variables with respect to the cointegration vector. When this assumption holds both approaches coincide. If not, the shocks Cochrane called transitory are not totally transitory. In this case, the conventional VAR approach with the assumption of the weak exogeneity may overstate the magnitude of transitory shocks and understate that of permanent shocks. We find that the permanent components of GDP and stock prices are much larger than those estimates of Cochrane, although substantial (but much smaller than in Cochrane (1994)) variations in GDP growth and stock returns are attributed to transitory shocks.

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Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we20070525.

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Date of creation: May 2007
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Handle: RePEc:cte:werepe:we20070525
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  1. Ribba, Antonio, 1997. "A note on the equivalence of long-run and short-run identifying restrictions in cointegrated systems," Economics Letters, Elsevier, vol. 56(3), pages 273-276, November.
  2. Barsky, Robert B & De Long, J Bradford, 1993. "Why Does the Stock Market Fluctuate?," The Quarterly Journal of Economics, MIT Press, vol. 108(2), pages 291-311, May.
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