Cointegration in return series and its effect on short‐term prediction

Abstract

Refers to previous research on the relationship between returns for different asset classes and on cointegration; and applies Johansen’s (1988) methodology to develop a prediction model. Uses 1978‐1995 data on five US asset classes (treasury bills, long‐term bonds, large capitalization common stocks, unsecuritized real estate and securitized real estate equity) to investigate cointegration between them. Shows that the index of unsecuritized real estate is positively related to treasury bills and negatively related to long‐term bonds and securitized real estate; and that returns for it can be forecast more accurately by using VECM models rather than unrestricted VAR models. Considers the implications for portfolio allocation, compares the results with other research fundings and calls for further research.