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Fully Modified Narrow-Band Least Squares Estimation of Stationary Fractional Cointegration

  • Morten Ørregaard Nielsen

    ()

    (Queen's University and CREATES)

  • Per Frederiksen

    ()

    (Nordea Markets)

We consider estimation of the cointegrating relation in the stationary fractional cointegration model which has found important application recently, especially in financial economics. Previous research on this model has considered a semiparametric narrow-band least squares (NBLS) estimator in the frequency domain, often under a condition of non-coherence between regressors and errors at the zero frequency. We show that in the absence of this condition, the NBLS estimator is asymptotically biased, and also that the bias can be consistently estimated. Consequently, we introduce a fully modified NBLS estimator which eliminates the bias, and indeed enjoys a faster rate of convergence than NBLS in general. We also show that local Whittle estimation of the integration order of the errors can be conducted consistently on the residuals from NBLS regression, whereas the estimator has the same asymptotic distribution as if the errors were observed only under the condition of non-coherence. Furthermore, compared to much previous research, the development of the asymptotic distribution theory is based on a different spectral density representation, which is relevant for multivariate fractionally integrated processes, and the use of this representation is shown to result in lower asymptotic bias and variance of the narrow-band estimators. We also present simulation evidence and a series of empirical illustrations to demonstrate the feasibility and empirical relevance of our methodology.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1171.pdf
File Function: First version 2008
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1171.

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Length: 41 pages
Date of creation: Jul 2008
Date of revision:
Handle: RePEc:qed:wpaper:1171
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