Normalization in cointegrated time series systems

Abstract

Abstract A method for normalizing cointegrating vectors is proposed for cointegrated time series systems containing multiple cointegrating vectors, a method requiring that an identity matrix appear in the normalized cointegrating matrix with unit coefficients attached to the endogenous or choice variables. The preferred method causes the normalized cointegrating matrix and the adjustment matrix to be consistent with the implications of static and dynamic economic theory. Alternative normalizations generate cointegrating and adjustment matrices that do not match up well with economic theory and do not reveal the testable restrictions implied by static economic theory.