A Simple Approach to Robust Inference in a Cointegrating System
25 Pages Posted: 7 Dec 2000
Date Written: January 2000
Cointegration requires all the variables in the system to have exact unit roots; accordingly it is conventional for researchers to test for a unit root in each variable prior to a cointegration analysis. Unfortunately, these unit root tests are not powerful. Meanwhile, conventional cointegration methods are not at all robust to slight violations of the requirement that each variable has a unit root. In this paper I show how this difficulty may be circumvented by instrumenting the regressors in the cointegrating regression by deterministic polynomial time trends, or by artificially generated random walks.
Keywords: Cointegration, Local to Unit Roots, Robustness, Instrumental Variables
JEL Classification: C22
Suggested Citation: Suggested Citation