Testing Hypotheses in an I(2) Model with Applications to the Persistent Long Swings in the Dmk/$ Rate
CREATES Research Paper 2008-3
35 Pages Posted: 25 Jun 2008
Date Written: January 18, 2008
This paper discusses a number of likelihood ratio tests on long-run relations and common trends in the I(2) model and provide new results on the test of overidentifying restrictions on betaxt and the asymptotic variance for the stochastic trends parameters, alpha 1: How to specify deterministic components in the I(2)model is discussed at some length. Model specification and tests are illustrated with an empirical analysis of long and persistent swings in the foreign exchange market between Germany and USA. The data analyzed consist of nominal exchange rates, relative prices, US in.ation rate, two long-term interest rates and two short-term interest rates over the 1975-1999 period. One important aim of the paper is to demonstrate that by structuring the data with the help of the I(2) model one can achieve a better understanding of the empirical regularities underlying the persistent swings in nominal exchange rates, typical in periods of floating exchange rates.
Keywords: PPP puzzle, Forward premium puzzle, cointegrated VAR, likelihood inference
JEL Classification: C32, C52, F41
Suggested Citation: Suggested Citation