Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. Roland Füss ?

● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. Roland Füss Statistik SS Financial Data Analysis ●

Chapter 6:

Multivariate Cointegration Analysis

1

........................ VAR(1) .................................................. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr...........................................Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr....................... 3 VI.....2 VAR(p)-Model .........................................An Example .............4 Testing the Rank of Cointegration .............. Multivariate Cointegration Analysis ............................................. 3 VI......... 14 VI........................................................1 The Simpelst Case: p = 1........................................... 16 2 ......................... Roland Füss Statistik SS Financial Data Analysis ● Contents: VI..................Johansen Test ....................... 12 VI......................................3 Model Specification.......

Johansen Test VI.1 The Simpelst Case: p = 1. Roland Füss Statistik SS Financial Data Analysis ● VI. VAR(1) For example. the Euro and the Yen. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. Within these three I(1) variables we can find up to two cointegrating relations due to the interest rate parity and stationary expected changes in the rate of exchange. there is a three dimensional vector Y consisting of the three month interest rates for the US dollar. Multivariate Cointegration Analysis . Y 0 Y 1 Y Z Z 1 0 1 1 3 .

In this simple case. Roland Füss Statistik SS Financial Data Analysis ● As we seen before. 4 . Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. we have a VAR(1) model for the M I(1) variables in levels. we can write: Yt = µ + ΓYt-1 + εt where: Y. µ and ε are (Mx1) vectors and Γ is a (MxM) matrix.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.

5 .I)Yt-1 = λγ’Yt-1 = λZt-1 where γ’ is the (rxM) matrix of the cointegration coefficients and λ is a (Mxr) matrix. On the right side there is a vector of constants as well as another I(0) vector ε. the term (Γ .Yt-1 + εt or ∆Yt = µ + (A1 .I)Yt-1 must be also I(0). Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.I)Yt-1 + εt ∆Yt = µ + (Γ . Roland Füss Statistik SS Financial Data Analysis ● By subtracting the lagged vectors Y from both sides of the equation we receive the following relation: Yt . Thus.Yt-1 = µ + ΓYt-1 . On the other hand. If the variables are not cointegrated.I)Yt-1 + εt In this equation we have an I(0) vector on the left hand side. then the matrix Γ must be a unit matrix I. this term can be written as a I(0) variable: (Γ .Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. if there exists r cointegrated relations (Z is a (rx1) vector).

I).e Γ = I. I(0). Roland Füss Statistik SS Financial Data Analysis ● When multiplying with the cointegration matrix the latter results in the (MxM) matrix (Γ . it has the rank r. This term is I(0) and λ can be interpreted as the matrix of the M times r error correction coefficients: ∆Yt = µ + λZt-1 + εt This model is a generalization of the ECM in the previous section. 6 . This means that the number of cointegrated relations is determined by the rank of the matrix. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. If the initial model constitutes a VAR(p) model then the error correction representation contains additionally (p-1) difference terms. If r equals M we are concerned with M stationary level data. In the case of a VAR(1) model there appears no lagged differences in the error correction model.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. the model reduced to a VAR model in differences (M independent random walks). i. In the marginal case r = 0. Since the matrix (Γ .I) can be represented by the product of a (rxM) and a (Mxr) matrix.

Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. Even more. r = M-1 are tested using likelihood ratio (LR) tests. In the formulation of a VAR(p) model we receive the equation: ∆yt = A0 + Πyt-1 + ∑ Γ ∆y i i=1 p-1 t −i + Bx t + εt As all factors in this equation except Π yt-1 are clearly stationary if the variables are cointegrated.I) under the assumption of normal distributed error variables. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. where the relevant elements of the α matrix are adjustment coefficients and the β matrix contains the cointegrating vectors. the system should be reduced to one containing only them. …. 7 . it means that also Π yt-1 must be stationary. their number is given by the rank of Π. Π can be decomposed as Π = αβ’. r = 1. every cointegration relationship has to appear in Π. Roland Füss Statistik SS Financial Data Analysis ● The approach of Johansen is based on the maximum likelihood estimation of the matrix (Γ . As the interest lies in α and β. Furthermore. Following the estimation the hypotheses r = 0.

where Σ00. S10 and S11. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. the asymptotic variance of R0t is Σ11 and the asymptotic covariance matrix of β’R1t and R0t is β’Σ10. The procedure is to maximize the likelihood function first with respect to α holding β constant and then maximize with respect to β. and Σ11 are the population counterparts of S00. …. ∆yt-(p-1) and then Yt-1 on the same variables. one should regress ∆yt on ∆yt-1. Σ10. The residuals are denoted respectively R0t and R1t. Roland Füss Statistik SS Financial Data Analysis ● To do that. S 11   Johansen (1991) shows that the asymptotic variance of β’R1t is β’Σ11β. Now the regression equation is reduced to R0t = αβ’R1t + et This is a multivariate regression problem:  S 00  S  10 S 01   is the matrix of sums of squares and sums of products of R0t and R1t. For α the result is: α’ = (β’S11β)-1β’S10 8 .Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.

Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.λI = 0 The roots of this equation are the r canonical correlations between R0t and R1t. ∆Yt-(p-1). …. By further mathematical manipulations this is equivalent to the finding of the characteristic roots of the equation: -1 -1 S 11S 10 S 00 S 00 . 9 . Roland Füss Statistik SS Financial Data Analysis ● The conditional maximum of the likelihood function with respect to β is (L(β))-2/T = |S00-S01β(β’S11β)-1β’S10| So maximization of the likelihood function with respect to β means minimization of this determinant. It means that those linear combinations of Yt-1 will be selected that are highly correlated to linear combinations of ∆Yt after conditioning on the lagged variables ∆Yt-1. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.

the maximum likelihood function will be (under the assumption of normal distributed error terms): L -2 / T max ˆ = S 00 ∏ (1 . the estimation problem is a canonical correlation analysis of the current ∆Yt and the lagged ∆Y. 10 . Roland Füss Statistik SS Financial Data Analysis ● Denoting with λi the characteristic value. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.λ i ) i=1 n Therefore.

Since we have not to deal with stationary variables. If the statistic is bigger than the critical value. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. …. 11 .λ r + 1 ) If the statistic is bigger than the critical value. the null hypothesis of exactly r cointegrated vectors is rejected. but with I(1) variables. The critical values for both test are derived from the trace and maximum eigenvalue of the stochastic matrix and depend on whether we include a trend (either linear or quadratic) or a constant in the VAR model. the test values are not χ2 and follow a different distribution that is tabulated by Johansen and Juselius. λ n are the smallest characteristic roots.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.λ i ) i=r +1 n ˆ ˆ where λ r +1 . The maximum eigenvalue statistic is ˆ λmax = -Tln(1. Roland Füss Statistik SS Financial Data Analysis ● The trace statistic is ˆ λ trace = -T ∑ ln(1 . the null hypothesis of at most r cointegrating vectors is rejected.

I)yt-2 + (A2 + A1 .I)yt-2 + (A1 .I)∆yt-1 + (A2 + A1 .2 VAR(p)-Model Consider a VAR of order p with M I(1) variables in levels: yt = A0 + A1yt-1 + A2yt-2 + … + Apyt-p + Bxt + εt ∆yt = A0 + (A1 . Roland Füss Statistik SS Financial Data Analysis ● VI.I)yt-3 + (A2 + A1 .I)yt-1 .Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.I)yt-2 + A3yt-3 + … + Apyt-p + Bxt + εt ∆yt = A0 + (A1 . I = unit vector where: yt-p is I(1) and Γpyt-p is I(0) 12 .I)yt-3 + … + Apyt-p + Bxt + εt ∆yt = A0 + Γ1∆yt-1 + Γ2∆yt-2 + … + Γp-1∆yt-p-1 + Γpyt-p + Bxt + εt with: Γi = (Ai + Ai-1 + … + A1).I)∆yt-1 + (A2 + A1 .I)∆yt-2 + (A3 + A2 + A1 .(A1 .I)∆yt-1 + (A2 + A1 .I)yt-1 + A2yt-2 + A3yt-3 + … + Apyt-p + Bxt + εt ∆yt = A0 + (A1 .I)yt-3 + A3)yt-3 +…+ Apyt-p + Bxt + εt ∆yt = A0 + (A1 .I)yt-2 + A2yt-2 + A3yt-3 + … + Apyt-p + Bxt + εt ∆yt = A0 + (A1 . Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.

xt is a d-vector of deterministic variables. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. and εt is a vector of innovations. with: Π = ∑ A i .∑ Aj p i=1 p j=i+1 13 . zp := Γpyt-p is I(0) or ∆yt = A0 + Πyt-1 + ∑ Γ i ∆y t −i + Bx t + εt i=1 p -1 where yt is a k-vector of non-stationary I(1) variables.I and Γ i = . We may rewrite the VAR as. Roland Füss Statistik SS Financial Data Analysis ● Γp calculates stationary linear combinations of the non-stationary y and the rows of Γp are the cointegrating vectors for the elements of y.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.

The level data yt have linear trends but the cointegrating equations have only intercepts: H(r): Πyt-1 + Bxt = α(β’yt-1 + ρ0) + α┴γ0 14 .Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. The level data yt have no deterministic trends and the cointegrating equations do not have intercepts: H(r): Πyt-1 + Bxt = αβ’yt-1 2.3 Model Specification Eviews considers the following five cases considered by Johansen (1995): 1. The level data yt have no deterministic trends and the cointegrating equations have intercepts: H(r): Πyt-1 + Bxt = α(β’yt-1 + ρ0) 3. Roland Füss Statistik SS Financial Data Analysis ● VI.

When a deterministic term appears both inside and outside the cointegrating relation. The level data yt and the cointegrating equations have linear trends: H(r): Πyt-1 + Bxt = α(β’yt-1 + ρ0 + ρ1t) + α┴γ0 5. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. Roland Füss Statistik SS Financial Data Analysis ● 4. The level data yt have quadratic trends and the cointegrating equations have linear trends: H(r): Πyt-1 + Bxt = α(β’yt-1 + ρ0 + ρ1t) + α┴(γ0 + γ1t) The terms associated with α┴ are the deterministic terms “outside” the cointegrating relations. we identify the part inside the error correction term by regressing the cointegration relations β’yt on a constant (and linear trend). 15 . EViews uses a different identification method so that the error correction term has a sample mean of zero. the decomposition is not uniquely identified.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. More specifically. Johansen (1995) identifies the part that belongs inside the error correction term by orthogonally projecting the exogenous terms on to the α space so that α┴ is the null space of α such that α’α┴ = 0.

79480 -25.80419* -25.374514 -23.35433 -25.69582 -25.58075 -25.74880 -25.17976 -25.09898 * indicates lag order selected by the criterion LR: sequential modified LR test statistic (each test at 5% level) FPE: Final prediction error AIC: Akaike information criterion SC: Schwarz information criterion HQ: Hannan-Quinn information criterion 16 .37426 -24.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.1675 35.26e-15 1.60371 11.70e-15 1.50e-15 1.411987 11.648 2740.39994 6.72143 -24.11203* 12.762 2727. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.005 2701.20814 44.26049 -25.20717 -3.345746 -23.55e-15 1.49283 -25.02200 -24.58459 -25.394046 -23.48229* -25.733 2734.4 Testing the Rank of Cointegration .10097 -25.An Example a) The Choice of the optimal Lag Length Lag LogL LR FPE AIC SC HQ 0 1 2 3 4 5 6 7 8 9 10 354.54129 -24. Roland Füss Statistik SS Financial Data Analysis ● VI.43308 -25.35e-15 1.86089 29.78404 -25.74e-06 9.25e-15* 1.28e-15 1.47496 -25.88648 -24.10159 -25.35907 9.603 2659.939 2717.000 2746.15473* -25.35e-15 1.70448 -3.2837 2472.20072 18.72888 -25.35610 -25.38927 -25.772 361.508 2678.710 2753.32e-15 1.77395 -25.39e-15 -3.72666 -25.414 NA 4154.

011335 0. Roland Füss Statistik SS Financial Data Analysis ● b) Trace statistics Unrestricted Cointegration Rank Test (Trace) Hypothesize d No.75529 15. of CE(s) Eigenvalue None * At most 1 * At most 2 0.49471 3.91097 0.0433 0.05 level * denotes rejection of the hypothesis at the 0.841466 0.0001 0.79707 15.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr.9150 Trace test indicates 2 cointegrating eqn(s) at the 0.071604 5.30E-05 Trace Statistic 48.05 Critical Value Prob.** 29. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.142281 0.05 level **MacKinnon-Haug-Michelis (1999) p-values 17 .

49.91 is higher than 15. We saw in class the differences between the trace and maximal e igenvalue tests. The trace statistic reports in the first block tests the null hypothesis of r cointegrated relations against the alternative of k cointegrating relations. where k is the number of endogenous variables. This suggests that there exist two cointegrated relations. Roland Füss Statistik SS Financial Data Analysis ● The portion of the output tells you whether there is cointegration and the number of cointegrated vectors.75 lies outside the interval between 0 and 29. Here one cannot reject the null of two cointegrating vectors using the trace test. The latter can be evaluated from the column of eigenvalues provided.79. The null hypothesis r = 0 and r ≤ 1 can clearly be rejected. The calculated test value of 48.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. which lies near zero. We can see from the second column that the first two eigenvalues are much higher compared to the last eigenvalue. 18 . Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr. Also the second test value of 15.

of CE(s) Max-Eigen Eigenvalue 0.** 21.142281 0.0007 0.05 level **MacKinnon-Haug-Michelis (1999) p-values 19 .84433 15.0273 0.89963 0.13162 14.071604 5.011335 0.26460 3.30E-05 Statistic 32.9150 None * At most 1 * At most 2 Max-eigenvalue test indicates 2 cointegrating eqn(s) at the 0.Lehrstuhl für Empirische Wirtschaftsforschung und Ökonometrie Department of Empirical Research and Econometrics Dr. Roland Füss ? ● 2007 II: Schließende Statistik Winter Term 2007/08 Dr.841466 0. Roland Füss Statistik SS Financial Data Analysis ● c) Maximum eigenvalues statistics Unrestricted Cointegration Rank Test (Maximum Eigenvalue) Hypothesized No.05 level * denotes rejection of the hypothesis at the 0.05 Critical Value Prob.

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