On Markov Error-Correction Models, with an Application to Stock Prices and Dividends
Journal of Applied Econometrics, Vol. 19, pp. 69-88, 2004
Posted: 6 Dec 2004
This paper considers Markov error-correction (MEC) models in which deviations from the long-run equilibrium are characterised by different rates of adjustment. To motivate our analysis and illustrate the various issues involved, our discussion is structured around the analysis of the long-run properties of US stock prices and dividends. It is shown that the MEC model is flexible enough to account for situations where deviations from the long-run equilibrium are nonstationary in one state of nature and allows us to test for such a possibility. An empirical specification procedure to establish the existence of MEC adjustment in practice is also presented. This is based on a multi-step test procedure that exploits the differences between the global and local characteristics of systems with MEC adjustment.
Keywords: Cointegration, Error-correction model, Markov chain, Stock prices
JEL Classification: C22, C32, G12
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