6. bounds test for cointegration within ardl or vecm

1
Data Analysis & Forecasting Faculty of Development Economics Phung Thanh Binh (2010) 1 TIME SERIES ANALYSIS BOUNDS TEST FOR COINTEGRATION WITHIN ARDL MODELLING APPROACH Another way to test for cointegration and causality is the Bounds Test for Cointegration within ARDL modelling approach. This model was developed by Pesaran et al. (2001) and can be applied irrespective of the order of integration of the variables (irrespective of whether regressors are purely I (0), purely I (1) or mutually cointegrated). This is specially linked with the ECM models and called VECM. 1. THE MODEL The ARDL modelling approach involves estimating the following error correction models: yt m 1 j j t j n 1 i i t i 1 t y 2 1 t y 1 y 0 t u X Y X Y Y + γ + β + α + α + α = = - = - - - (1) xt m 1 j j t j n 1 i i t i 1 t x 2 1 t x 1 x 0 t u Y X X Y X + δ + θ + α + α + α = = - = - - - (2) Important note is the same as the Standard Granger Causality. 2. TEST PROCEDURE Suppose we have Y t and X t are nonstationary. THE DYNAMIC GRANGER CAUSALITY is performed as follows: Step 1: Testing for the unit root of Y t and X t (using either DF, ADF, or PP tests) Suppose the test results indicate that Y t and X t have different orders of integration. Step 2: Testing for cointegration between Y t and X t (usually use Bounds test approach) For equations 1 and 2, the F-test (normal Wald test) is used for investigating one or more long-run relationships. In the case of one or more long-run relationships, the F-test indicates which variable should be normalized. In Equation 1, when Y is the dependent variable, the null hypothesis of no cointegration is H 0 : α 1y = α 2y = 0 and the alternative hypothesis of cointegration is H 1 : α 1y α 2y 0. On the other hand, in Equation 2, when X is the dependent variable, the null hypothesis of no cointegration is H 0 : α 1x = α 2x = 0 and the alternative hypothesis of cointegration is H 1 : α 1x α 2x 0. Step 3: Testing for Granger Causality? Questions: How to explain the test results?

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Page 1: 6. bounds test for cointegration within ardl or vecm

Data Analysis & Forecasting Faculty of Development Economics

Phung Thanh Binh (2010) 1

TIME SERIES ANALYSIS BOUNDS TEST FOR COINTEGRATION WITHIN ARDL

MODELLING APPROACH

Another way to test for cointegration and causality is the Bounds Test for Cointegration within ARDL modelling approach. This model was developed by Pesaran et al. (2001) and can be applied irrespective of the order of integration of the variables (irrespective of whether regressors are purely I (0), purely I (1) or mutually cointegrated). This is specially linked with the ECM models and called VECM.

1. THE MODEL The ARDL modelling approach involves estimating the following error correction models:

yt

m

1jjtj

n

1iiti1ty21ty1y0t uXYXYY +∆γ+∆β+α+α+α=∆ ∑∑

=−

=−−− (1)

xt

m

1jjtj

n

1iiti1tx21tx1x0t uYXXYX +∆δ+∆θ+α+α+α=∆ ∑∑

=−

=−−− (2)

Important note is the same as the Standard Granger Causality.

2. TEST PROCEDURE

Suppose we have Yt and Xt are nonstationary.

THE DYNAMIC GRANGER CAUSALITY is performed as follows:

Step 1: Testing for the unit root of Yt and Xt

(using either DF, ADF, or PP tests)

Suppose the test results indicate that Yt and Xt have different orders of integration.

Step 2: Testing for cointegration between Yt and Xt

(usually use Bounds test approach)

For equations 1 and 2, the F-test (normal Wald test) is used for investigating one or more long-run relationships. In the case of one or more long-run relationships, the F-test indicates which variable should be normalized. In Equation 1, when Y is the dependent variable, the null hypothesis of no cointegration is H0: α1y = α2y = 0 and the alternative hypothesis of cointegration is H1: α1y ≠ α2y ≠ 0. On the other hand, in Equation 2, when X is the dependent variable, the null hypothesis of no cointegration is H0: α1x = α2x = 0 and the alternative hypothesis of cointegration is H1: α1x ≠ α2x ≠ 0.

Step 3: Testing for Granger Causality?

Questions: How to explain the test results?