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Inappropriate Detrending and Spurious Cointegration

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  • Heejoon Kang

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

Abstract

The empirical literature is abundant with detrended cointegration, where cointegration relationships are tested and estimated with deterministic trend terms. Cointegration is, however, critically dependent on whether time series is detrended or not. A series of Monte Carlo experiments show that inappropriately detrended time series tend to exhibit a spurious cointegration. Although true time series are known not to be cointegrated, inappropriately detrended series tend to be cointegrated. Foreign exchange rates are analyzed to demonstrate the relevance and importance of the inappropriate detrending in the cointegration analysis.

Suggested Citation

  • Heejoon Kang, 2006. "Inappropriate Detrending and Spurious Cointegration," Working Papers 2006-14, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  • Handle: RePEc:iuk:wpaper:2006-14
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    File URL: http://kelley.iu.edu/riharbau/RePEc/iuk/wpaper/bepp2006-14-kang.pdf
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    References listed on IDEAS

    as
    1. Nelson, Charles R & Kang, Heejoon, 1981. "Spurious Periodicity in Inappropriately Detrended Time Series," Econometrica, Econometric Society, vol. 49(3), pages 741-751, May.
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    More about this item

    Keywords

    Deterministic trend; Foreign exchange rates; Monte Carlo study; Stochastic trend;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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