Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 221: Power and Bias of Likelihood Based Inference in the Cointegration Model under Fractional Cointegration

Michael K. Andersson and Mikael P. Gredenhoff
Additional contact information
Michael K. Andersson: Dept. of Economic Statistics, Stockholm School of Economics, Postal: P.O. Box 6501, S-113 83 Stockholm, Sweden
Mikael P. Gredenhoff: Dept. of Economic Statistics, Stockholm School of Economics, Postal: P.O. Box 6501, S-113 83 Stockholm, Sweden

Abstract: This paper investigates how fractional cointegration affects the common maximum likelihood cointegration procedure. It is shown that the likelihood ratio test of no cointegration has considerable power against fractional alternatives. In contrast to the case of a cointegrated system, the usual maximum likelihood estimator gives severely biased estimates of the long-run relation under fractional cointegration. This suggests that the standard likelihood approach should be used with caution and that a test to separate fractionally cointegrated series from series that are cointegrated of an integer order should be executed prior to estimation.

Keywords: Error correction; likelihood ratio test; maximum likelihood; fractional integration

JEL-codes: C12; C32

20 pages, February 24, 1998

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