Fractional cointegration and tests of present value models

Guglielmo Maria Caporale and Luis Gil-Alana

No 2000,15, SFB 373 Discussion Papers from Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes

Abstract: This paper tests the validity of Present Value (PV) models of stock prices by employing a two-step strategy for testing the null hypothesis of no cointegration against alternatives which are fractionally cointegrated. Monte Carlo simulations are conducted to evaluate the power and size properties of this test, which is shown to outperform existing ones, and to compute appropriate critical values for finite samples. It is found that stock prices and dividends are both I(1) nonstationary series, but they are fractionally cointegrated. This implies that, although there exists a long-run relationship which is consistent with PV models, the equilibrium errors exhibit slow mean reversion. As the error correction term possesses long memory, deviations from equilibrium are highly persistent.

Keywords: fractional integration; Efficient Markets Hypothesis (EMH); Present Value (PV) models; fractional cointegration (search for similar items in EconPapers)
JEL-codes: C22 C32 G12 G14 (search for similar items in EconPapers)
Date: 2000
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Citations: View citations in EconPapers (1)

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Journal Article: Fractional cointegration and tests of present value models (2004)
Journal Article: Fractional cointegration and tests of present value models (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:sfb373:200015

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