Scandinavian Working Papers in Economics

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

No 517: Error correction in DHSY

Ann-Charlotte Eliasson and Timo Teräsvirta ()
Additional contact information
Ann-Charlotte Eliasson: Deutsche Bank, Fixed Income & Relative Value Research, Postal: Grosse Gallustrasse 10-14, EG, D-60323 Frankfurt am Main, Germany
Timo Teräsvirta: Dept. of Economic Statistics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: In this note, we consider the contradiction between the fact that the best fit for the UK consumption data in Davidson et al. (1978) is obtained using an equation with an intercept but without an error correction term, whereas the equation with error correction and without the intercept has better post-sample forecasting properties than the former equation. This contradiction is explained and the two equations reconciled in a nonlinear framework by applying a smooth transition regression model to the data.

Keywords: consumption equation; model misspecification testing; nonlinearity; smooth transition regression

JEL-codes: C22; E21

8 pages, November 21, 2002

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