EconPapers    
Economics at your fingertips  
 

Cointegration test with stationary covariates and the CDS-bond basis during the financial crisis

Jason Wu () and Aaron L. Game

No 2011-18, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)

Abstract: This paper proposes a residual based cointegration test with improved power. Based on the idea of Hansen (1995) and Elliott & Jansson (2003) in the unit root testing case, stationary covariates are used to improve the power of the residual based Augmented Dickey Fuller (ADF) test. The asymptotic null distribution contains difficult to estimate nuisance parameters for which there is no obvious method of estimation, therefore we propose a bootstrap methodology to obtain test critical values. Local-to-unity asymptotics and Monte Carlo simulations are used to evaluate the power of the test in large and small samples, respectively. These exercises show that the addition of covariates increases power relative to the ADF and Johansen tests, and that the power depends on the long-run correlation between the covariates and the cointegration candidates. The new test is used to test for cointegration between Credit Default Swap (CDS) and corporate bond spreads for a panel of U.S. firms during the 2007-2009 financial crisis. The new test finds stronger evidence for cointegration between the two spreads for more firms, relative to ADF and Johansen tests.

Keywords: Swaps (Finance); Corporate bonds; Econometric models (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-ecm and nep-ets
Date: 2011
References: View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
http://www.federalreserve.gov/pubs/feds/2011/201118/201118abs.html (text/html)
http://www.federalreserve.gov/pubs/feds/2011/201118/201118pap.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2011-18

Ordering information: This working paper can be ordered from
http://www.federalre ... /feds/fedsorder.html

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ().

 
Page updated 2019-10-16
Handle: RePEc:fip:fedgfe:2011-18