Scandinavian Working Papers in Economics

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

No 233: Maximum likelihood estimation of the multivariate fractional cointegrating model

Johan Lyhagen ()
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Johan Lyhagen: Dept. of Economic Statistics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, S-113 83 Stockholm, Sweden

Abstract: Departures from an economic equilibrium should be mean reverting. The deviations are often assumed to be integrated of order zero but this is too restrictive. It is sufficient that the shocks are integrated of an order less than one, i.e. they may be fractionally integrated. A fractionally cointegrated system is developed. Further, estimation and testing are discussed, analytically and by Monte Carlo simulations. The Monte Carlo simulations shows that it is much more severe to ignore fractional cointegration than incorporating it when it is not present.

Keywords: Fractional integration; Granger representation theorem; Likelihood ratio test; Monte Carlo.

JEL-codes: C12; C13; C32

22 pages, April 22, 1998

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