Econometric Issues When Modeling with a Mixture of I(1) and I(0) Variables

32 Pages Posted: 27 Aug 2013

See all articles by Lance A. Fisher

Lance A. Fisher

Macquarie University - Department of Economics; Macquarie University, Macquarie Business School

Hyeon‐Seung Huh

Yonsei University - Department of Economics

Adrian Pagan

Australian National University (ANU) - Research School of Social Sciences (RSSS); UNSW Australia Business School, School of Economics

Date Written: April 17, 2013

Abstract

This paper considers structural models when both I(1) and I(0) variables are present. It is necessary to extend the traditional classification of shocks into permanent and transitory and we do this by introducing a mixed shock. The extra shocks coming from introducing I(0) variables into a system are then classified as either mixed or transitory. Conditions are derived upon the nature of the Structural VAR in the event that these extra shocks are transitory. In many instances this might be the most reasonable identification. But there do exist applications where the shocks are mixed. We analyze what happens when there are mixed shocks, finding that it changes a number of ideas that have become established from the co-integration literature. An example where there is a mixed shock is Peersman’s (2005) model where the structural shock in the interest rate, an I(0) variable, has a permanent effect on two of the I(1) variables. We look at the results he establishes and investigate a number of scenarios involving either treating the shock as transitory or allowing it to be mixed, as well as allowing it to have some extra zero long-run effects to what Peersman considered. Finally, the paper looks at how one applies sign restrictions to an SVAR which features mixed shocks, illustrating this with Peersman’s model. One needs to exercise considerable care in how one does this.

Suggested Citation

Fisher, Lance A. and Huh, Hyeon-Seung and Pagan, Adrian R., Econometric Issues When Modeling with a Mixture of I(1) and I(0) Variables (April 17, 2013). CAFE Research Paper No. 13.11, Available at SSRN: https://ssrn.com/abstract=2316297 or http://dx.doi.org/10.2139/ssrn.2316297

Lance A. Fisher

Macquarie University - Department of Economics ( email )

Sydney NSW 2109
Australia

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Hyeon-Seung Huh

Yonsei University - Department of Economics ( email )

50 Yonsei-Ro
Seoul, 120-749
Korea

Adrian R. Pagan (Contact Author)

Australian National University (ANU) - Research School of Social Sciences (RSSS) ( email )

Canberra, Australian Capital Territory 0200
Australia
+61 2 6249 2216 (Phone)
+61 06 249 0182 (Fax)

UNSW Australia Business School, School of Economics

High Street
Sydney, NSW 2052
Australia

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