International Finance Discussion Papers (IFDP)
December 1999
A Simple Approach to Robust Inference in a Cointegrating System
Jonathan H. Wright
Abstract:
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 have 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
PDF: Full Paper
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