A model selection approach to jointly testing for structural breaks and cointegration with application to the Eurocurrency interest rates market

Abstract

All tests involving both structural breaks and cointegration are parametric. As a complement to the classical hypothesis testing for empirical researchers, we suggest the use of a one-step model selection approach to simultaneously specifying lag orders, cointegration ranks, and structural breaks. The performances of the four popular information criteria along with a LM-based parametric test are shown in extensive simulation studies. Applying the approach to study linkages in the Eurocurrency interest rates market, we find that six major short-term rates were subject to a structural break and the cointegration rank also changed following the break.