Model Selection Procedures in Bounds Test of Cointegration: Theoretical Comparison and Empirical Evidence

Waqar Badshah,Mehmet Bulut

doi:10.3390/economies8020049

Waqar Badshah, Mehmet Bulut

Open Access

https://doi.org/10.3390/economies8020049

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Journal: Economies	Publication Date: Jun 8, 2020
Citations: 7	License type: CC BY 4.0

Affiliation: İstanbul Sabahattin Zaim Üniversitesi

Abstract

Only unstructured single-path model selection techniques, i.e., Information Criteria, are used by Bounds test of cointegration for model selection. The aim of this paper was twofold; one was to evaluate the performance of these five routinely used information criteria {Akaike Information Criterion (AIC), Akaike Information Criterion Corrected (AICC), Schwarz/Bayesian Information Criterion (SIC/BIC), Schwarz/Bayesian Information Criterion Corrected (SICC/BICC), and Hannan and Quinn Information Criterion (HQC)} and three structured approaches (Forward Selection, Backward Elimination, and Stepwise) by assessing their size and power properties at different sample sizes based on Monte Carlo simulations, and second was the assessment of the same based on real economic data. The second aim was achieved by the evaluation of the long-run relationship between three pairs of macroeconomic variables, i.e., Energy Consumption and GDP, Oil Price and GDP, and Broad Money and GDP for BRICS (Brazil, Russia, India, China and South Africa) countries using Bounds cointegration test. It was found that information criteria and structured procedures have the same powers for a sample size of 50 or greater. However, BICC and Stepwise are better at small sample sizes. In the light of simulation and real data results, a modified Bounds test with Stepwise model selection procedure may be used as it is strongly theoretically supported and avoids noise in the model selection process.

Highlights

The concept of avoiding the spurious regression in case the time series under consideration are I(1) was firstly explored by (Engle and Granger 1987) in their seminal paper
Elimination, and Stepwise) by assessing their size and power properties at different sample sizes based on Monte Carlo simulations, and second was the assessment of the same based on real economic data
We considered these countries because BRICS is one of the essential alliances of five nations, and these are five rapidly emerging economies representing four different continents (Lissovolik and Vinokurov 2019; Huang and Osborne 2017)

Summary

Introduction

The concept of avoiding the spurious regression in case the time series under consideration are I(1) was firstly explored by (Engle and Granger 1987) in their seminal paper. They argued that spurious cointegration could be avoided if the I(1) time series are cointegrated, i.e., having a long-run relationship. Since the development of the Bounds test of cointegration by (Pesaran et al 2001), it has been widely and frequently used by researchers to examine the level relationship between different macroeconomic and financial variables (Adeleye et al 2018; Tsoulfidis and Tsaliki 2014; Tang 2014). The five unstructured procedures, commonly known as Economies 2020, 8, 49; doi:10.3390/economies8020049 www.mdpi.com/journal/economies

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