Functional Coefficient Cointegration Models Subject to Time–Varying Volatility with an Application to the Purchasing Power Parity

Yundong Tu and Ying Wang

Oxford Bulletin of Economics and Statistics, 2019, vol. 81, issue 6, 1401-1423

Abstract: This paper analyses functional coefficient cointegration models with both stationary and non‐stationary covariates, allowing time‐varying (unconditional) volatility of a general form. The conventional kernel weighted least squares (KLS) estimator is subject to potential efficiency loss, and can be improved by an adaptive kernel weighted least squares (AKLS) estimator that adapts to heteroscedasticity of unknown form. The AKLS estimator is shown to be as efficient as the oracle generalized kernel weighted least squares estimator asymptotically, and can achieve significant efficiency gain relative to the KLS estimator in finite samples. An illustrative example is provided by investigating the Purchasing Power Parity hypothesis.

Date: 2019
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