Cointegration: Its Fatal Flaw and a Proposed Solution
23 Pages Posted: 8 Jan 2020
There are 2 versions of this paper
Cointegration: Its Fatal Flaw and a Proposed Solution
Cointegration: Its Fatal Flaw and a Proposed Solution
Date Written: December 17, 2019
Abstract
It has been argued that whenever regression models involve nonstationary and trending variables, the estimation methods appropriate to stationary series cannot be applied to such models and instead require cointegration techniques. Unfortunately, the extant methodology applied to cointegration is a trap: if the error term of a cointegration regression is made up of omitted relevant regressors, then, even though they are integrated to the same order, the dependent and the independent variables of the regression are not cointegrated! This paper presents a way out this dilemma by proposing a remedy based on time-varying coefficient (TVC) modeling that over-comes all the shortcomings described in the paper.
Keywords: integrated variable, cointegrated variables, cointegrating vector, nonstationary variable, time-varying coefficient model
JEL Classification: C20, C22
Suggested Citation: Suggested Citation