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Beyond Co-Integration: Modelling Co-Movements in Macro finance

  • Karim M. Abadir

    ()

    (Tanaka Business School, Imperial College London, UK)

  • Gabriel Talmain

    ()

    (Department of Economics, University of Glasgow, UK)

Macroeconomic and aggregate financial series share an unconventional type of nonlinear dynamics. Existing techniques (like co-integration) model these dynamics incompletely, hence generating seemingly paradoxical results. To avoid this, we provide a methodology to disentangle the long-run relation between variables from their own dynamics, and illustrate with two applications. First, in the forward-premium puzzle, adding a component quantifying the persistent nonlinear dynamics of exchange rates yields substantial predictability and makes the forward-premium term insignificant. Second, S&P 500 grows in a pattern of momentum followed by reversal, forming long cycles around a trend given by GDP, a stable non-breaking relation since WWII.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 25_12.

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Date of creation: Jun 2012
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Handle: RePEc:rim:rimwps:25_12
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