Abstract
A regime dependent VAR model is suggested that allows long memory (fractional integration) in each of the regime states as well as the possibility of fractional cointegration. The model is relevant in describing the price dynamics of electricity prices where the transmission of power is subject to occasional congestion periods. For a system of bilateral prices non-congestion means that electricity prices are identical whereas congestion makes prices depart. Hence, the joint price dynamics implies switching between essentially a univariate price process under non-congestion and a bivariate price process under congestion. At the same time it is an empirical regularity that electricity prices tend to show a high degree of fractional integration, and thus that prices may be fractionally cointegrated. An empirical analysis using Nord Pool data shows that even though the prices strongly co-move under non-congestion, the prices are not, in general, fractional cointegrated in the congestion state.
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