Fractional Cointegration Rank Estimation

Katarzyna Łasak and Carlos Velasco

No 14-021/III, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This discussion paper led to a publication in the Journal of Business & Economic Statistics , 2015, 33(2), 241-254.

We consider cointegration rank estimation for a p-dimensional Fractional Vector Error Correction Model. We propose a new two-step procedure which allows testing for further long-run equilibrium relations with possibly different persistence levels. The first step consists in estimating the parameters of the model under the null hypothesis of the cointegration rank r=1,2,…,p-1. This step provides consistent estimates of the order of fractional cointegration, the cointegration vectors, the speed of adjustment to the equilibrium parameters and the common trends. In the second step we carry out a sup-likelihood ratio test of no-cointegration on the estimated p-r common trends that are not cointegrated under the null. The order of fractional cointegration is re-estimated in the second step to allow for new cointegration relationships with different memory. We augment the error correction model in the second step to adapt to the representation of the common trends estimated in the first step. The critical values of the proposed tests depend only on the number of common trends under the null, p-r, and on the interval of the orders of fractional cointegration b allowed in the estimation, but not on the order of fractional cointegration of already identified relationships. Hence this reduces the set of simulations required to approximate the critical values, making this procedure convenient for practical purposes. In a Monte Carlo study we analyze the finite sample properties of our procedure and compare with alternative methods. We finally apply these methods to study the term structure of interest rates.

Keywords: Error correction model; Gaussian VAR model; Likelihood ratio tests; Maximum likelihood estimation (search for similar items in EconPapers)
JEL-codes: C12 C15 C32 (search for similar items in EconPapers)
Date: 2014-02-13
New Economics Papers: this item is included in nep-ets
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Fractional Cointegration Rank Estimation (2015)
Working Paper: Fractional cointegration rank estimation (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20140021

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