Cointegration Test

The finding that many macro time series may contain a unit root has spurred the
development of the theory of non-stationary time series analysis. Engle and Granger
(1987) pointed out that a linear comination of t!o or more non-stationary series may e
stationary. "f such a stationary linear comination e#ists$ the non-stationary time series
are said to e cointegrated. The stationary linear comination is called the cointegrating
e%uation and may e interpreted as a long-run e%uilirium relationship among the
variales.
The purpose of the cointegration test is to determine !hether a group of non-stationary
series are cointegrated or not. &s e#plained elo!$ the presence of a cointegrating
relation forms the asis of the 'E( specification. E'ie!s implements '&)-ased
cointegration tests using the methodology developed in *ohansen (1991$ 199+a).
(onsider a '&) of order ,
(-7.--)
!here is a -vector of non-stationary "(1) variales$ is a -vector of deterministic variales$
and is a vector of innovations. .e may re!rite this '&) as$
(-7.-/)
!here,
(-7.-0)
Granger1s representation theorem asserts that if the coefficient matri# has reduced ran2 $
then there e#ist matrices and each !ith ran2 such that and is "(3). is the numer of
cointegrating relations (the cointegrating ran2) and each column of is the cointegrating
vector. &s e#plained elo!$ the elements of are 2no!n as the ad4ustment parameters in
the 'E( model. *ohansen1s method is to estimate the matri# from an unrestricted '&)
and to test !hether !e can re4ect the restrictions implied y the reduced ran2 of .
5o! to 6erform a (ointegration Test
To carry out the *ohansen cointegration test$ select 'ie!7(ointegration Test... from the
group or '&) !indo! toolar. The (ointegration Test 8pecification page prompts you
for information aout the test.
9ote that since this is a test for cointegration$ this test is only valid !hen you are !or2ing
!ith series that are 2no!n to e nonstationary. :ou may !ish first to apply unit root tests
to each series in the '&). 8ee ;nit )oot Test for details on carrying out unit root tests in
E'ie!s.
<eterministic Trend 8pecification
:our series may have non=ero means and deterministic trends as !ell as stochastic
trends. 8imilarly$ the cointegrating e%uations may have intercepts and deterministic
trends. The asymptotic distriution of the >) test statistic for cointegration does not have
the usual distriution and depends on the assumptions made !ith respect to deterministic
trends. Therefore$ in order to carry out the test$ you need to ma2e an assumption
regarding the trend underlying your data.
?or each ro! case in the dialog$ the (@"9TEA column lists the deterministic variales
that appear inside the cointegrating relations (error correction term)$ !hile the @;T8"<E
column lists the deterministic variales that appear in the 'E( e%uation outside the
cointegrating relations. (ases - and 0 do not have the same set of deterministic terms in
the t!o columns. ?or these t!o cases$ some of the deterministic term is restricted to
elong only in the cointegrating relation. ?or cases / and +$ the deterministic terms are
common in the t!o columns and the decomposition of the deterministic effects inside and
outside the cointegrating space is not uni%uely identifiedB see the technical discussion
elo!.
"n practice$ cases 1 and + are rarely used. :ou should use case 1 only if you 2no! that all
series have =ero mean. (ase + may provide a good fit in-sample ut !ill produce
implausile forecasts out-of-sample. &s a rough guide$ use case - if none of the series
appear to have a trend. ?or trending series$ use case / if you elieve all trends are
stochasticB if you elieve some of the series are trend stationary$ use case 0.
"f you are not certain !hich trend assumption to use$ you may choose the 8ummary of all
+ trend assumptions option (case C) to help you determine the choice of the trend
assumption. This option indicates the numer of cointegrating relations under each of the
+ trend assumptions$ and you !ill e ale to assess the sensitivity of the results to the
trend assumption.
Technical <iscussion
E'ie!s considers the follo!ing five deterministic trend cases considered y *ohansen
(199+a$ pp. 83-80),
1. The level data have no deterministic trends and the cointegrating e%uations do
not have intercepts,
-. The level data have no deterministic trends and the cointegrating e%uations have
intercepts,
/. The level data have linear trends ut the cointegrating e%uations have only
intercepts,
0. The level data and the cointegrating e%uations have linear trends,
+. The level data have %uadratic trends and the cointegrating e%uations have linear
trends,
The terms associated !ith are the deterministic terms DoutsideD the cointegrating
relations. .hen a deterministic term appears oth inside and outside the cointegrating
relation$ the decomposition is not uni%uely identified. *ohansen (199+a) identifies the part
that elongs inside the error correction term y orthogonally pro4ecting the e#ogenous
terms onto the space so that is the null space of such that . E'ie!s uses a different
identification method so that the error correction term has a sample mean of =ero. Eore
specifically$ !e identify the part inside the error correction term y regressing the
cointegrating relations on a constant (and linear trend).
E#ogenous 'ariales
The test dialog allo!s you to specify additional e#ogenous variales to include in the test
'&). The constant and linear trend should not e listed in the edit o# since they are
specified using the five Trend 8pecification options. "f you choose to include e#ogenous
variales$ e a!are that the critical values reported y E'ie!s do not account for these
variales.
The most commonly added deterministic terms are seasonal dummy variales. 9ote$
ho!ever$ that if you include standard 3-1 seasonal dummy variales in the test '&)$ this
!ill affect oth the mean and the trend of the level series . To handle this prolem$
*ohansen (199+a$ page 80) suggests using centered (orthogonali=ed) seasonal dummy
variales$ !hich shift the mean !ithout contriuting to the trend. (entered seasonal
dummy variales for %uarterly and monthly series can e generated y the commands,
series dF% G Hseas(%) - 170
series dFm G Hseas(m) - 171-
for %uarter and month $ respectively.
>ag "ntervals
:ou should specify the lags of the test '&) as pairs of intervals. 9ote that the lags are
specified as lags of the first differenced terms used in the au#iliary regression$ not in
terms of the levels. ?or e#ample$ if you type D1 -D in the edit field$ the test '&)
regresses on $ $ and any other e#ogenous variales that you have specified. 9ote that in
terms of the level series the largest lag is /. To run a cointegration test !ith one lag in
the level series$ type D3 3D in the edit field.
"nterpreting )esults of a (ointegration Test
&s an e#ample$ the first part of the cointegration test output for the four-variale system
used y *ohansen and *uselius (1993) for the <anish data is sho!n elo!.
&s indicated in the header of the output$ the test assumes no trend in the series !ith a
restricted intercept in the cointegration relation (second trend specification in the dialog)$
includes three orthogonali=ed seasonal dummy variales <1-</$ and uses one lag in
differences (t!o lags in levels) !hich is specified as D1 1D in the edit field.
9umer of (ointegrating )elations
The first part of the tale reports results for testing the numer of cointegrating relations.
T!o types of test statistics are reported. The first loc2 reports the so-called trace
statistics and the second loc2 (not sho!n aove) reports the ma#imum eigenvalue
statistics. ?or each loc2$ the first column is the numer of cointegrating relations under
the null hypothesis$ the second column is the ordered eigenvalues of the matri# in
(-7.-0)$ the third column is the test statistic$ and the last t!o columns are the +I and 1I
critical values. The (nonstandard) critical values are ta2en from @ster!ald->enum
(199-)$ !hich differ slightly from those reported in *ohansen and *uselius (1993).
To determine the numer of cointegrating relations conditional on the assumptions made
aout the trend$ !e can proceed se%uentially from to until !e fail to re4ect. The result of
this se%uential testing procedure is reported at the ottom of each tale loc2.
The trace statistic reported in the first loc2 tests the null hypothesis of cointegrating
relations against the alternative of cointegrating relations$ !here is the numer of
endogenous variales$ for . The alternative of cointegrating relations corresponds to the
case !here none of the series has a unit root and a stationary '&) may e specified in
terms of the levels of all of the series. The trace statistic for the null hypothesis of
cointegrating relations is computed as,
(-7.-+)
!here is the i-th largest eigenvalue of the matri# in (-7.-0) !hich is reported in the
second column of the output tale.
The second loc2 of the output reports the ma#imum eigenvalue statistic !hich tests the
null hypothesis of cointegrating relations against the alternative of cointegrating
relations. This test statistic is computed as,
(-7.-C)
for .
There are a fe! other details to 2eep in mind,
(ritical values are availale for up to series. &lso note that the critical values depend on
the trend assumptions and may not e appropriate for models that contain other
deterministic regressors. ?or e#ample$ a shift dummy variale in the test '&) implies a
ro2en linear trend in the level series .
The trace statistic and the ma#imum eigenvalue statistic may yield conflicting results. ?or
such cases$ !e recommend that you e#amine the estimated cointegrating vector and ase
your choice on the interpretaility of the cointegrating relationsB see *ohansen and
*uselius (1993) for an e#ample.
"n some cases$ the individual unit root tests !ill sho! that some of the series are
integrated$ ut the cointegration test !ill indicate that the matri# has full ran2 (
). This apparent contradiction may e the result of lo! po!er of the cointegration tests$
stemming perhaps from a small sample si=e or serving as an indication of specification
error.
(ointegrating relations
The second part of the output provides estimates of the cointegrating relations and the
ad4ustment parameters . &s is !ell 2no!n$ the cointegrating vector is not identified
unless !e impose some aritrary normali=ation. The first loc2 reports estimates of and
ased on the normali=ation $ !here is defined in *ohansen (199+a). 9ote that the
transpose of is reported under ;nrestricted (ointegrating (oefficients so that the first
ro! is the first cointegrating vector$ the second ro! is the second cointegrating vector$
and so on.
The remaining loc2s report estimates from a different normali=ation for each possile
numer of cointegrating relations . This alternative normali=ation e#presses the first
variales as functions of the remaining variales in the system. &symptotic standard
errors are reported in parentheses for the parameters that are identified.
"mposing )estrictions
8ince the cointegrating vector is not identified$ you may !ish to impose your o!n
identifying restrictions. )estrictions can e imposed on the cointegrating vector (elements
of the matri#) and7or on the ad4ustment coefficients (elements of the matri#). To impose
restrictions in a cointegration test$ select 'ie!7(ointegration Test... and specify the
options in the Trend 8pecification ta as e#plained aove. Then ring up the 'E(
)estrictions ta. :ou !ill enter your restrictions in the edit o# that appears !hen you
chec2 the "mpose )estrictions o#,
)estrictions on the (ointegrating 'ector
To impose restrictions on the cointegrating vector $ you must refer to the (i$4)-th element
of the transpose of the matri# y J(i$4). The i-th cointegrating relation has the
representation,
J(i$1)Ky1 L J(i$-)Ky- L ... L J(i$2)Ky2
!here y1$ y-$ ... are the (lagged) endogenous variale. Then$ if you !ant to impose the
restriction that the coefficient on y1 for the second cointegrating e%uation is 1$ you !ould
type the follo!ing in the edit o#,
J(-$1) G 1
:ou can impose multiple restrictions y separating each restriction !ith a comma on the
same line or typing each restriction on a separate line. ?or e#ample$ if you !ant to
impose the restriction that the coefficients on y1 for the first and second cointegrating
e%uations are 1$ you !ould type,
J(1$1) G 1
J(-$1) G 1
(urrently all restrictions must e linear (or more precisely affine) in the elements of the
matri#. 8o for e#ample
J(1$1) K J(-$1) G 1
!ill return a synta# error.
)estrictions on the &d4ustment (oefficients
To impose restrictions on the ad4ustment coefficients$ you must refer to the (i$4)-th
elements of the matri# y &(i$4). The error correction terms in the i-th 'E( e%uation !ill
have the representation,
&(i$1)K(ointE%1 L &(i$-)K(ointE%- L ... L &(i$r)K(ointE%r
)estrictions on the ad4ustment coefficients are currently limited to linear homogeneous
restrictions so that you must e ale to !rite your restriction as $ !here is a 2no!n
matri#. This condition implies$ for e#ample$ that the restriction$
&(1$1) G &(-$1)
is valid ut,
&(1$1) G 1
!ill return a restriction synta# error.
@ne restriction of particular interest is !hether the i-th ro! of the matri# is all =ero. "f
this is the case$ then the i-th endogenous variale is said to e !ea2ly e#ogenous !ith
respect to the parameters. 8ee *ohansen (199-) for the definition and implications of
!ea2 e#ogeneity. ?or e#ample$ if !e assume that there is only one cointegrating relation
in the 'E($ to test !hether the second endogenous variale is !ea2ly e#ogenous !ith
respect to you !ould enter,
&(-$1) G 3
To impose multiple restrictions$ you may either separate each restriction !ith a comma
on the same line or type each restriction on a separate line. ?or e#ample$ to test !hether
the second endogenous variale is !ea2ly e#ogenous !ith respect to in a 'E( !ith t!o
cointegrating relations$ you can type,
&(-$1) G 3
&(-$-) G 3
:ou may also impose restrictions on oth and . 5o!ever$ the restrictions on and must
e independent. 8o for e#ample$
&(1$1) G 3
J(1$1) G 1
is a valid restriction ut,
&(1$1) G J(1$1)
!ill return a restriction synta# error.
"dentifying )estrictions and Jinding )estrictions
E'ie!s !ill chec2 to see !hether the restrictions you provided identify all cointegrating
vectors for each possile ran2. The identification condition is chec2ed numerically y the
ran2 of the appropriate *acoian matri#B see Jos!i42 (199+) for the technical details.
&symptotic standard errors for the estimated cointegrating parameters !ill e reported
only if the restrictions identify the cointegrating vectors.
"f the restrictions are inding$ E'ie!s !ill report the >) statistic to test the inding
restrictions. The >) statistic is reported if the degrees of freedom of the asymptotic
distriution is positive. 9ote that the restrictions can e inding even if they are not
identifying$ (e.g. !hen you impose restrictions on the ad4ustment coefficients ut not on
the cointegrating vector).
@ptions for )estricted Estimation
Estimation of the restricted cointegrating vectors and ad4ustment coefficients generally
involves an iterative process. The 'E( )estrictions ta provides iteration control for the
ma#imum numer of iterations and the convergence criterion. E'ie!s estimates the
restricted and using the s!itching algorithm as descried in Jos!i42 (199+). Each step
of the algorithm is guaranteed to increase the li2elihood and the algorithm should
eventually converge (though convergence may e to a local rather than a gloal
optimum). :ou may need to increase the numer of iterations in case you are having
difficulty achieving convergence at the default settings.
)esults of )estricted (ointegration Test
"f you impose restrictions in the (ointegration Test vie!$ the output !ill first display the
test results !ithout the restrictions as descried aove. The second part of the output
egins y displaying the results of the >) test for inding restrictions.
"f the restrictions are not inding for a particular ran2$ the corresponding ro!s !ill e
filled !ith 9&s. "f the restrictions are inding ut the algorithm did not converge$ the
corresponding ro! !ill e filled !ith an asteris2 DKD. (:ou should redo the test y
increasing the numer of iterations or rela#ing the convergence criterion.) ?or the
e#ample output displayed aove$ !e see that the single restriction is inding only under
the assumption that there is one cointegrating relation. (onditional on there eing only
one cointegrating relation$ the >) test does not re4ect the imposed restriction at
conventional levels.
The output also reports the estimated and imposing the restrictions. 8ince the
cointegration test does not specify the numer of cointegrating relations$ results for all
ran2s that are consistent !ith the specified restrictions !ill e displayed. ?or e#ample$
suppose the restriction is,
J(-$1) G 1
8ince this is a restriction on the second cointegrating vector$ E'ie!s !ill display results
for ran2s (if the '&) has only variales$ E'ie!s !ill return an error message pointing
out that the Dimplied ran2 from restrictions must e of reduced orderD).
?or each ran2$ the output reports !hether convergence !as achieved and the numer of
iterations. The output also reports !hether the restrictions identify all cointegrating
parameters under the assumed ran2. "f the cointegrating vectors are identified$ asymptotic
standard errors !ill e reported together !ith the parameters .