Scandinavian Working Papers in Economics
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Hanken School of Economics Working Papers, Hanken School of Economics

No 539:
Tests for Cointegration Rank and the Initial Condition

Niklas Ahlgren () and Mikael Juselius ()

Abstract: Many economic events involve initial observations that substantially deviate from long-run steady state. Initial conditions of this type have been found to impact diversely on the power of univariate unit root tests, whereas the impact on multivariate tests is largely unknown. This paper investigates the impact of the initial condition on tests for cointegration rank. We compare the local power of the widely used likelihood ratio (LR) test with the local power of a test based on the eigenvalues of the companion matrix. We find that the power of the LR test is increasing in the magnitude of the initial condition, whereas the power of the other test is decreasing. The behaviour of the tests is investigated in an application to price convergence.

Keywords: asymptotic local power; cointegration; companion matrix; convergence; initial condition; likelihood ratio test; unit root; (follow links to similar papers)

43 pages, May 13, 2009

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Publication Data:
Forthcoming as Ahlgren, Niklas and Mikael Juselius, 'Tests for Cointegration Rank and the Initial Condition ' in Empirical Economics., 2011.

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