Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2002:3: A Monte Carlo Study on the Pitfalls in Determining Deterministic Components in Cointegrating Models

Göran Hjelm () and Martin W Johansson ()
Additional contact information
Göran Hjelm: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden
Martin W Johansson: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: In this paper we examine, by means of Monte Carlo simulation, the properties of the so called 'Pantula principle' for the simultaneous determination of rank and deterministic components in a vector error correction model. Examining the five models contained within the Johansen methodology, we find that the 'Pantula principle' is heavily biased towards choosing model 3 (unrestriced constant) when model 4 (restricted trend) is the true one. We suggest a modification that reduces this bias to an important extent

Keywords: Cointegration; Deterministic components; Monte Carlo simulation

JEL-codes: C15; C32; C52

13 pages, February 5, 2002

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