Académique Documents
Professionnel Documents
Culture Documents
Cointegration Analysis:
A Review of the Available Processes
and Procedures and an Application
If the unit root tests find that a series contain one unit root, the
appropriate route in this case is to transform the data by differencing
the variables prior to their inclusion in the regression model, but this
incurs a loss of important long-run information.
Applying the unit root tests which allow for the possible presence of
the structural break prevents obtaining a test result which is possibly
biased towards non-rejection, as suspected by Perron (1989).
Also, since this procedure can identify the date of the structural
break, it facilitates the analysis of whether a structural break on a
certain variable is associated with a particular event such as a
change in government policy, a currency crisis, war and so forth.
Multiple Structural Breaks
The Zivot-Andrews and Perron-Vogelsang
(1992) unit root tests allow for one structural
break, whereas the Clemente-Montanes-
Reyes (1998) unit root test allows for two
structural breaks in the mean of the
series196.
A search is made for a linear combination of such variables such that the
combination is stationary. If such a stationary combination exists, then the
variables are said to be cointegrated, meaning even though they are
individually not stationary, they are bound by an equilibrium relationship.
In this case, the application of traditional econometric modelling
to non-stationary time series data generates meaningful results.
It goes without saying that the correct choice of the order of the ARDL
model is very important in the long-run analysis. In this respect, the ARDL
approach has the advantage that it takes a sufficient number of lags to
capture the data generating process in a general-to-specific modelling
framework
Furthermore, the lag orders can be selected based on four
different selection criteria taking into consideration the results
of the diagnostic tests for residual serial correlation, functional
form misspecification, non-normality, and heteroscedasticity.
The order of the lags in the ARDL model are selected using the
appropriate selection criteria such as Akaike Information
Criterion (AIC), Schwartz Bayesian Criterion (SBC), Hannan-
Quinn Criterion (HQC) and R2 ensuring that there is no evidence
of residual serial correlation, functional form misspecification,
non-normality and heteroscedasticity.
In the presence of structural breaks, the diagnostic
tests of the selected models will most likely suggest
that the estimated model suffers from the non-
normality problem.
The dummy variables are set equal to zero for all observations
except the month in which the observation goes beyond the
threshold of two standard errors. In these months, the dummy
variable takes on the value of 1.
For example, Figure I plots the residuals of several econometric
models with structural breaks and 2 standard errors.
In both CUSUM and CUSUMSQ, the related null hypothesis is that all
coefficients are stable.
The CUSUM test uses the cumulative sum of recursive residuals based
on the first observations and is updated recursively and plotted against
break point. The test is more suitable for detecting systematic changes
in the regression coefficients.
If however, either of the parallel lines are crossed then the null
hypothesis of parameter stability is rejected at the 5 percent
significance level.
For example in Figure II and III, which plot the CUSUM and
CUSUMSQ tests, the plots of the CUSUM and CUSUMSQ statistics are
generally confined within the 5 percent critical value bounds,
indicating the absence of any instability of the coefficients
Thus, the parameters of the model do not suffer from any structural
instability.
Thank you !