Linear cointegration of nonlinear time series with an application to interest rate dynamics

Barry Jones and Travis Nesmith

No 2007-03, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We derive a definition of linear cointegration for nonlinear stochastic processes using a martingale representation theorem. The result shows that stationary linear cointegrations can exhibit nonlinear dynamics, in contrast with the normal assumption of linearity. We propose a sequential nonparametric method to test first for cointegration and second for nonlinear dynamics in the cointegrated system. We apply this method to weekly US interest rates constructed using a multirate filter rather than averaging. The Treasury Bill, Commercial Paper and Federal Funds rates are cointegrated, with two cointegrating vectors. Both cointegrations behave nonlinearly. Consequently, linear models will not fully replicate the dynamics of monetary policy transmission.

Keywords: time series analysis; Cointegration; Interest rates (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-ecm, nep-fmk and nep-mac
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Related works:
Journal Article: Linear Cointegration of Nonlinear Time Series with an Application to Interest Rate Dynamics (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2007-03

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