Showing papers on "Cointegration published in 2006"

Testing for error correction in panel data

Abstract: This paper proposes new error correction-based cointegration tests for panel data. The limiting distributions of the tests are derived and critical values provided. Our simulation results suggest that the tests have good small-sample properties with small size distortions and high power relative to other popular residual-based panel cointegration tests. In our empirical application, we present evidence suggesting that international healthcare expenditures and GDP are cointegrated once the possibility of an invalid common factor restriction has been accounted for.

The cointegrated VAR model : methodology and applications

Abstract: BRIDGING ECONOMICS AND ECONOMETRICS 1 Introduction 2 Models and Relations in Economics and Econometrics 3 The Probability Approach in Econometrics and the VAR SPECIFYING THE VAR MODEL 4 The Unrestricted VAR 5 The Cointegrated VAR Model 6 Deterministic Components in the I(1) Model 7 Estimation in the I(1) Model 8 Determination of Cointegration Rank TESTING HYPOTHESES ON COINTEGRATION 9 Recursive Tests of Constancy 10 Testing Restrictions on Beta 11 Testing Restrictions on Alpha IDENTIFICATION 12 Identification of the Long-Run Structure 13 Identification of the Short-Run Structure 14 Identification of Common Trends 15 Identification of a Structural MA Model THE I(2) MODEL 16 Analyzing I(2) Data with the I(1) Model 17 The I(2) Model: specification and estimation 18 Testing Hypotheses in the I(2) Model A METHODOLOGICAL APPROACH 19 Specific-to-General and General-to-Specific 20 Wage, Price, and Unemployment Dynamics 21 Foreign Transmission Effects: Denmark versus Germany 22 Collecting the Threads Appendix A: The Asymptotic Tables for Cointegration Rank

Panel cointegration tests of the Fisher effect

Abstract: Most empirical evidence suggests that the Fisher effect, stating that inflation and nominal interest rates should cointegrate with a unit slope on inflation, does not hold, a finding at odds with many theoretical models. This paper argues that these results can be attributed in part to the low power of univariate tests, and that the use of panel data can generate more powerful tests. For this purpose, we propose two new panel cointegration tests that can be applied under very general conditions, and that are shown by simulation to be more powerful than other existing tests. These tests are applied to a panel of quarterly data covering 20 OECD countries between 1980 and 2004. The evidence suggest that the Fisher effect cannot be rejected once the panel evidence on cointegration has been taken into account. Copyright (C) 2007 John Wiley & Sons, Ltd. (Less)

An Empirical Comparison of Credit Spreads between the Bond Market and the Credit Default Swap Market

Abstract: This paper compares the pricing of credit risk in the bond market and the fast-growing credit default swap (CDS) market. The cointegration test confirms that the theoretical parity relationship between the two credit spreads holds as a long-run equilibrium condition. Nevertheless, substantial deviation from the parity can arise in the short run. The panel data study and the VECM analysis both suggest that the deviation is largely due to the higher responsiveness of CDS premia to changes in credit conditions. Moreover, it exhibits a certain degree of persistence in that only 10% of price discrepancies can be removed within a business day.

Household Debt Sustainability: What Explains Household Non-Performing Loans? An Empirical Analysis

Abstract: Sound household financial conditions are relevant for both financial and monetary stability. Therefore, we analyse household financial fragility in a sample of euro area countries with the aim to shed some light on the nature of the large debt increase accumulated in recent years. We focus on household arrears on payment obligations, which are one of the most direct measures of financial stress of the sector. The probability of falling into arrears is derived from a life-cycle type of model and is investigated empirically using a cross-section and time series approach. We analyse cointegration and model arrears within an errorcorrection framework. The results suggest that the financial conditions of households might become more vulnerable to adverse shocks in their income and wealth.

The Long‐Run Relationship between House Prices and Income: Evidence from Local Housing Markets

Abstract: Many in the housing literature argue that house prices and income are cointegrated. I show that the data do not support this view. Standard tests using 27 years of national-level data do not find evidence of cointegration. However, standard tests for cointegration have low power, especially in small samples. I use panel-data tests for cointegration that are more powerful than their time-series counterparts to test for cointegration in a panel of 95 metro areas over 23 years. Using a bootstrap approach to allow for cross-correlations in city-level house-price shocks, I show that even these more powerful tests do not reject the hypothesis of no cointegration. Thus the error-correction specification for house prices and income commonly found in the literature may be inappropriate.

Testing for Panel Cointegration with Multiple Structural Breaks

Abstract: This paper proposes a Lagrange multiplier (LM) test for the null hypothesis of cointegration that allows for the possibility of multiple structural breaks in both the level and trend of a cointegrated panel regression. The test is general enough to allow for endogenous regressors, serial correlation and an unknown number of breaks that may be located at different dates for different individuals. We derive the limiting distribution of the test and conduct a small Monte Carlo study to investigate its finite sample properties. In our empirical application to the solvency of the current account, we find evidence of cointegration between saving and investment once a level break is accommodated.

A Regime Switching Long Memory Model for Electricity Prices

Abstract: In this paper we develop a regime switching model which can generate long memory (fractional integration) in each of the regime states. This property is relevant in a number of cases. For instance, the deregulated market for electricity power in the Nordic countries is characterized by electricity spot prices with a high degree of long memory. It occurs that in some time periods bilateral prices are identical whereas in other periods the prices differ. The latter occurs when a capacity congestion exists across regions and multiple price areas will result. If the price series are fractionally integrated this means that in some regimes, an extreme form of fractional cointegration amongst prices will exist. We define a Markov switching fractional integration model from which the fractional orders of integration in separate states can be estimated using Maximum Likelihood techniques. The model is adapted to data for the Nordic electricity spot market, and we find that regime swithing and long memory are empirically relevant to co-exist. In particular, we find that the price behaviour for single markets can be very different depending upon the presence or absence of bottlenecks in electricity transmission. Using Monte Carlo forecasting we find that the regime switching model appears to be especially attractive in forecasting relative prices.

Macroeconomic variables and stock market interactions: new zealand evidence

Abstract: In this paper, we examine the relationships between the New Zealand Stock Index and a set of seven macroeconomic variables from January 1990 to January 2003 using cointegration tests. Specifically, we employ the Johansen Maximum Likelihood and Granger-causality tests to determine whether the New Zealand Stock Index is a leading indicator for macroeconomic vari- ables. In addition, this paper also investigates the short run dynamic linkages between NZSE40 and macroeconomic variables using innovation accounting analyses. In general, the NZSE40 is consistently determined by the interest rate, money supply and real GDP and there is no evidence that the New Zealand Stock Index is a leading indicator for changes in macroeconomic variables.

Bounds Testing Approach to Cointegration: An Examination of Foreign Direct Investment Trade and Growth Relationships

Abstract: This study examines the long-run impact of foreign direct investment and trade on economic growth in Ghana. Using an augmented aggregate production function (APF) growth model, we apply the bounds testing (ARDL) approach to cointegration which is more appropriate for estimation in small sample studies. The data span for the study is from 1970 to 2002. We found cointegration relations between growth and its determinants in the APF model. The results indicated the impact of FDI on growth to be negative which is consistent with other past studies. Trade however was found to have significant positive impact on growth.

Structural Vector Autoregressive Analysis for Cointegrated Variables

Abstract: Vector autoregressive (VAR) models are capable of capturing the dynamic structure of many time series variables. Impulse response functions are typically used to investigate the relationships between the variables included in such models. In this context the relevant impulses or innovations or shocks to be traced out in an impulse response analysis have to be specified by imposing appropriate identifying restrictions. Taking into account the cointegration structure of the variables offers interesting possibilities for imposing identifying restrictions. Therefore VAR models which explicitly take into account the cointegration structure of the variables, so-called vector error correction models, are considered. Specification, estimation and validation of reduced form vector error correction models is briefly outlined and imposing structural short- and long-run restrictions within these models is discussed.

Cointegration in panel data with breaks and cross-section dependence

Abstract: The power of standard panel cointegration statistics may be aected by misspeci…cation errors if structural breaks in the parameters generating the process are not accounted for. We therefore allow for structural breaks when testing the null hypothesis of no cointegration and propose tests that retain good properties in terms of empirical size and power. Response surfaces to approximate the …nite sample moments that are required to implement the statistics are provided. Since panel cointegration statistics rely on the assumption of cross- section independence, a generalisation of the tests to the common factor framework is carried out in order to allow for dependence among the units of the panel.

Panels with Nonstationary Multifactor Error Structures

Abstract: The presence of cross-sectionally correlated error terms invalidates much inferential theory of panel data models. Recently work by Pesaran (2006) has suggested a method which makes use of cross-sectional averages to provide valid inference for stationary panel regressions with multifactor error structure. This paper extends this work and examines the important case where the unobserved common factors follow unit root processes and could be cointegrated. It is found that the presence of unit roots does not affect most theoretical results, which continue to hold irrespective of the integration and the cointegration properties of the unobserved factors. This finding is further supported for small samples via an extensive Monte Carlo study. In particular, the results of the Monte Carlo study suggest that the cross-sectional average based method is robust to a wide variety of data generation processes and has lower biases than all of the alternative estimation methods considered in the paper.

Gold investment as an inflationary hedge: Cointegration evidence with allowance for endogenous structural breaks

Abstract: This note tests for the presence of a stable long-run relationship between the price of gold and inflation in the United States from 1945 to 2006 and from 1973 to 2006. Since both the gold market and the inflationary regime have been subjected to structural change over time, a novel unit root testing procedure is employed which allows for the timing of significant breaks to be estimated, rather than assumed exogenous. After taking these breaks into account, a modified cointegration approach provides strong evidence of a cointegrating relationship between gold and inflation in the post-war period and since the early 1970s. The results lend support to the widely held view that direct and indirect gold investment can serve as an effective inflationary hedge.

A comparison of some common methods for detecting Granger noncausality

Abstract: We compare testing strategies for Granger noncausality in vector autoregressions (VARs) that may or may not have unit roots and cointegration Sequential testing methods are examined; these test for cointegration and use either a differenced VAR or a vector error correction model (VECM), in which to undertake the main noncausality test Basically, these strategies attempt to verify the validity of appropriate standard limit theory We contrast such methods with an augmented lag approach that ensures the limiting χ2 null distribution irrespective of the data’s nonstationarity characteristics Our simulations involve bivariate and trivariate VARs in which we allow for the lag order to be selected by general to specific testing and by model selection criteria We find that the practice of pretesting for cointegration can result in severe overrejections of the noncausal null, whereas overfitting results in better control of the Type I error probability with often little loss in power

Higher Education, Real Income and Real Investment in China: Evidence From Granger Causality Tests

Abstract: This paper employs cointegration and error‐correction modelling to test the causal relationship between real income, real investment and tertiary education using data for the People’s Republic of China over the period 1952–1999. To proxy tertiary education we use higher education enrolments and higher education graduates in alternative empirical specifications. One of the paper’s main findings is that real income, real investment and tertiary education are cointegrated when real investment is the dependent variable, but are not cointegrated when either tertiary education or real income is the dependent variable. We also extend the in‐sample analysis to examine the decomposition of variance and impulse response functions.

Tax Policy and Entrepreneurship: New Time Series Evidence

Abstract: Have tax policies affected entrepreneurial activity in the U.S.? We extend the time series literature on this topic by using more recent data and modern econometric techniques to examine the importance of federal income, payroll, capital gains, corporate income, and estate taxes on self-employment rates. Regression results show that most of these taxes have significant but small effects on self-employment activity. A battery of cointegration and causality tests confirms the general finding that taxes can have significant influences on entrepreneurship, but they are likely to be ineffective tools for generating meaningful changes in entrepreneurial activity.

Testing the null of cointegration with structural breaks

Abstract: In this paper we propose an LM-Type statistic to test the null hypothesis of cointegration allowing for the possibility of a structural break, in both the deterministic and the cointegration vector. Our proposal focuses on the presence of endogenous regressors and analyses which estimation method provides better results. The test has been designed to be used as a complement to the usual non-cointegration tests in order to obtain stronger evidence of cointegration. We consider the cases of known and unknown break date. In the latter case, we show that minimizing the SSR results in a super-consistent estimator of the break fraction. Finally, the behaviour of the tests is studied through Monte Carlo experiments.

On the Estimation and Inference of a Panel Cointegration Model with Cross-Sectional Dependence

Abstract: Most of the existing literature on panel data cointegration assumes cross-sectional independence, an assumption that is difficult to satisfy. This paper studies panel cointegration under cross-sectional dependence, which is characterized by a factor structure. We derive the limiting distribution of a fully modified estimator for the panel cointegrating coefficients. We also propose a continuous-updated fully modified (CUP-FM) estimator. Monte Carlo results show that the CUP-FM estimator has better small sample properties than the two-step FM (2S-FM) and OLS estimators.

Tests of seasonal integration and cointegration in multivariate unobserved component models

Abstract: This paper considers tests of seasonal integration and cointegration for multivariate unobserved component models. First, the locally best invariant (LBI) test of the null hypothesis of a deterministic seasonal pattern against the alternative of seasonal integration is derived for a model with Gaussian i.i.d. disturbances and deterministic trend. Then the null hypothesis of seasonal cointegration is considered and a test for common nonstationary components at the seasonal frequencies is proposed. The tests are subsequently generalized to account for stochastic trends, weakly dependent errors and unattended unit roots. Asymptotic representations and critical values of the tests are provided, while the finite sample performance is evaluated by Monte Carlo simulation experiments. Finally, the tests are applied to the series of industrial production of the four largest countries of the European Monetary Union. It is found that Germany does not appear to cointegrate with the other countries at most seasonal frequencies, while there seems to exist a common nonstationary seasonal component between France, Italy and Spain. Copyright © 2006 John Wiley & Sons, Ltd.