Common Stochastic Trends Research Articles

The crucial relationship among energy commodity prices: Evidence from the Spanish electricity market

The main purpose of this article is twofold to analyze: (a) the long-term relation among the commodities prices and between spot electricity market price and commodity prices, and (b) the short-term dynamics among commodity prices and between electricity prices and commodity prices. Data between 2002 and 2005 from the Spanish electricity market was used. Econometric methods were used in the analysis of the commodity spot price, namely the vector autoregression model, the vector error correction model and the granger causality test. The co-integration approach was used to analyze the long-term relationship between the common stochastic trends of four fossil fuel prices. One of the findings in the long-term relation is that the prices of fuel and the prices of Brent are intertwined, though the prices of Brent ten to “move” to reestablish the price equilibrium. Another finding is that the price of electricity is explained by the evolution of the natural gas series.

Bootstrap LR Tests of Stationarity, Common Trends and Cointegration

The paper considers likelihood ratio (LR) tests of stationarity, common trends and cointegration for multivariate time series. As the distribution of these tests is not known, a bootstrap version is proposed via a state space representation. The bootstrap samples are obtained from the Kalman filter innovations under the null hypothesis. Monte Carlo simulations for the Gaussian univariate random walk plus noise model show that the bootstrap LR test achieves higher power for medium-sized deviations from the null hypothesis than a locally optimal and one-sided LM test, that has a known asymptotic distribution. The power gains of the bootstrap LR test are significantly larger for testing the hypothesis of common trends and cointegration in multivariate time series, as the alternative asymptotic procedure - obtained as an extension of the LM test of stationarity - does not possess properties of optimality. Finally, it is showed that the (pseudo) LR tests maintain good size and power properties also for non-Gaussian series. As an empirical illustration, we find evidence of two common stochastic trends in the volatility of the US dollar exchange rate against european and asian/pacific currencies.

Intraday return dynamics and volatility spillovers between NSE S&P CNX Nifty stock index and stock index futures

Using 5-min intraday transaction prices, this study investigates the relationship between the National Stock Exchange (NSE) S&P CNX Nifty futures and its underlying spot index in terms of both return and volatility. By applying Johansen–Juselius (J–J) cointegration analysis, we find evidence of single common stochastic trend, to which spot and futures prices move together in a long-run equilibrium path. The vector error correction model (VECM) and Granger causality test find that there is unidirectional causality running from futures to spot market. To examine the volatility spillovers between the markets, this study has used bivariate Generalized Autoregressive Conditional Heteroscedastic (GARCH) (1, 1) model with Baba, Engle, Kraft and Kroner (BEKK) parameterization and finds evidence of bidirectional volatility spillovers between spot and futures markets. However, there is pronounced spillover effect of a previous shock and volatility from the futures market to spot market. Hence, we conclude that Nifty futures prices lead spot prices and futures market largely contributes to price discovery. These findings have significant implications for traders in implementing hedging and arbitrage trading strategies, for portfolio managers in managing risk and also for policymakers in assessing market stability.

Robust global stock market interdependencies

In this paper, we examine the scope for in ternational stock portfolio diversification, from the viewpoint of a United States representative investor, in regard to both the Asian and the European stock markets. Our findings indicate that despite correlation style evidence to the contrary, the European stock markets provide a superior long-term diversification opportunity relative to that provided by the Asian stock markets. Hence, a short-term measurement of interdependence appears to be uninformative with respect to the diversification opportunities of investors with longer term investment horizons. In terms of methodology, we adopt common stochastic trend tests, including a common stochastic trend test which accounts for generalised autoregressive conditional heteroskedasticity effects in conjunction with the recursive estimation of these tests to estimate the development of long-term stock market interdependence linkages. Recursively estimated robust correlations between the international stock markets are utilised to reveal the nature of short-term stock market interdependence linkages.

Productivity and per capita GDP growth: The role of the forgotten factors

Average hourly productivity has often been used to draw conclusions on long run per capita GDP growth, based on the assumption of full utilization of labor resources. In this paper, we argue that a failure to recognize the potential significant wedges among the two variables – even in the long run – can be misleading. By applying both time series and panel cointegration techniques on data on 19 OECD countries, we fail to reject the hypothesis of the absence of a long run common stochastic trend among the two variables in the period 1980–2005. Furthermore, we apply a simple decomposition of GDP growth into five variables, including some related to the supply-side and demographics, so to verify the single contributions to income growth and variance over our period of interest. We conclude that variables that have been so far absent in the growth literature indeed have a non-negligible role in explaining the dynamics of long run per capita GDP growth. In particular, these “forgotten factors” (that we identify with the employment and the activity rates and a demographic ratio) matter more in better performing economies, where we also highlight that productivity has been less important in determining GDP growth than in relatively bad performers.

Cointegration and Long-Run Asset Allocation

We show that economic restrictions of cointegration between asset cash flows and aggregate consumption have important implications for return dynamics and optimal portfolio rules, particularly at long investment horizons. When cash flows and consumption share a common stochastic trend (i.e., are cointegrated), temporary deviations between their levels forecast long-horizon dividend growth rates and returns, and consequently, alter the term profile of risks and expected returns. We show that the optimal asset allocation based on the error-correction vector autoregression (EC-VAR) specification can be quite different relative to a traditional VAR that ignores the cointegrating relation. Unlike the EC-VAR, the commonly used VAR approach to model expected returns focuses on short-run forecasts and can considerably miss on long-horizon return dynamics, and hence, the optimal portfolio mix in the presence of cointegration. We develop and implement methods to account for parameter uncertainty in the EC-VAR setup and highlight the importance of the error-correction channel for optimal portfolio decisions at various investment horizons.

Steel consumption and economic activity in the UK: The integration and cointegration debate

This research examines whether a long-run stationary equilibrium relationship holds between economic activity and the consumption of crude steel within the UK. Using the theory of fractionally integrated and cointegrated processes, and allowing for the possibility that the equilibrium path changes abruptly at occasional points in time, it is possible to determine if steel consumption and economic activity follow a common stochastic trend or whether the two series randomly drift apart over time. Evidence is found to support such a long term relationship. This result is at odds with the conclusions drawn by previous researchers in the area. The reason for this difference may be due to these researchers concentrating only on I(0) and I(1) specifications, without consideration of fractional possibilities and also to a failure to account for structural breaks in the equilibrium relationship. Such conclusions are made within the framework of the ARFIMA methodology that yields reliable inferences on the degree of fractional integration and cointegration. Critical values for fractional contegration with an ARFIMA model in the presence of structural breaks are also derived in this paper.

Modeling Long-Run Cause of Death Mortality Trends

This paper models relationships between trends in cause of death mortality rates for five main causes of death (circulatory system, cancer, respiratory system, external causes, infectious and parasitic diseases) across nine major countries (USA, Australia, Switzerland, Japan, Singapore, Italy, Norway, Sweden, UK). Trends and relationships between mortality rates for causes of death are important since these trends are hidden in aggregate data. Vector Error Correction Models (VECM) are used to model the common trends in causes of death by country. A VECM is a multivariate dynamic system allowing for long-run relationships between variables and common stochastic trends. The paper demonstrates that mortality rates by causes of death have common stochastic trends in many countries but these also differ across countries highlighting the potential for geographical diversification of mortality trends. The results confirm long-run relationships exist between the five main causes of death, indicating dependence between these competing risks. Cause of death analysis provides valuable information that can improve the estimation of aggregate mortality trends.

Improving Longevity and Mortality Risk Models with Common Stochastic Long-Run Trends

Modeling mortality and longevity risk presents challenges because of the impact of improvements at different ages and the existence of common trends. Modeling cause of death mortality rates is even more challenging since trends and age effects are more diverse. Despite this, successfully modeling these mortality rates is critical to assessing risk for insurers issuing longevity risk products including life annuities. Longevity trends are often forecasted using a Lee-Carter model. A common stochastic trend determines age-based improvements. Other approaches fit an age-based parametric model with a time series or vector autoregression for the parameters. Vector Error Correction Models (VECM), developed recently in econometrics, include common stochastic long-run trends. This paper uses a stochastic parameter VECM form of the Heligman-Pollard model for mortality rates, estimated using data for circulatory disease deaths in the United States over a period of 50 years. The model is then compared with a version of the Lee-Carter model and a stochastic parameter ARIMA Heligman-Pollard model. The VECM approach proves to be an improvement over the Lee-Carter and ARIMA models as it includes common stochastic long-run trends.

Stock Market Fundamentals and Bubbles: Implications for Prices, GDP and Consumption

This paper examines the cointegrating relationships between UK quarterly stock prices, stock price fundamentals, GDP and consumption. Evidence reported supports cointegration between these four-variables, with results indicating three cointegrating vectors, or a single common stochastic trend. VAR models augmented with equilibrium relationships identified both separately and jointly from stock market and macroeconomic variables are estimated. The key results arising is that stock market fundamentals appear to drive the common stochastic trend, while deviations from stock market fundamentals, bubbles, have significant explanatory power for short-run movements in stock prices, GDP and consumption. This latter finding is confirmed using an alternate method for extracting the non-fundamental component from stock prices. Overall, these results suggest the importance of stock market fundamentals (ultimately corporate performance) as a driving force for long-run stock price and macroeconomic movement and of non-fundamental behaviour (ultimately confidence) for short-run changes in stock prices and macroeconomic activity.

Global Stock Market Interdependencies and long-term Portfolio Diversification

In this paper, we examine the scope for international stock portfolio diversification, from the viewpoint of a United States representative investor, in regard to both the Asian and the European stock markets. Our findings indicate that despite correlation style evidence to the contrary, the European stock markets provide a superior long-term diversification opportunity relative to that provided by the Asian stock markets. Hence, a short-term measurement of interdependence appears to be uninformative with respect to the diversification opportunities of investors with long-term investment horizons. In terms of methodology, we adopt common stochastic trend tests, including a common stochastic trend test which accounts for generalised autoregressive conditional heteroskedasticity effects in conjunction with the recursive estimation of these tests to estimate the development of long-term stock market interdependence linkages. Recursively estimated robust correlations between the international stock markets are utilised to reveal the nature of short-term stock market interdependence linkages.

Wages, Prices and Unemployment in Poland

The paper aims to analyze long-run relationships between labor market trends, wages, prices, interest rates and the exchange rate in Poland. We use a research approach known as cointegrated VAR analysis, which makes it possible to identify long-run tendencies and common stochastic trends as well as estimate the adjustment dynamics of the system (the pulling and pushing forces). The results show that we can find stable long-run cointegration relationships between the unemployment rate, wages and prices. We can confirm our two main research hypotheses formulated on the basis of theoretical formulations. First of all, increasing product market competition seems to be the main driving force behind the convergence of the Polish economy with more advanced European economies during the analyzed period. Second, we can confirm that the Polish inflation rate has adapted to the European purchasing power parity level over the long run, and we can also confirm a kind of Balassa-Samuelson effect on consumer prices.

Least Squares Asymptotics in Spurious and Cointegrated Panel Regressions with Common and Idiosyncratic Stochastic Trends*

AbstractThis article makes an analytical study of the effects of the presence of both common and idiosyncratic stochastic trends on the pooled least squares estimator. The results suggest that the usual result of asymptotic normality depends critically on the absence of the common stochastic trend.

Business cycles with a common trend in neutral and investment-specific productivity

This paper identifies a new source of business-cycle fluctuations. Namely, a common stochastic trend in neutral and investment-specific productivity. We document that in U.S. postwar quarterly data total factor productivity (TFP) and the relative price of investment are cointegrated. We show theoretically that TFP and the relative price of investment are cointegrated if and only if neutral and investment-specific productivity share a common stochastic trend. We econometrically estimate an RBC model augmented with a number of real rigidities and driven by a multitude of shocks. We find that in the context of our estimated model, innovations in the common stochastic trend explain a sizable fraction of the unconditional variances of output, consumption, investment, and hours.

The Term Structure of the Polish Interbank Rates. A Note on the Symmetry of their Reversion to the Mean

The empirical analysis of the term structure of the Polish interbank rates has revealed that the short and the long rates from the whole spectrum of maturities have evolved almost accordingly to the expectations hypothesis. They have exhibited common stochastic trends, their spreads have had cointegrating properties as well as much predictive power. Of all interest rates considered it is only a 3 month rate that has asymmetrically been reverting to the mean.

The long-run relationship between population and per capita income growth in China

This paper examines the nature of stationarity, cointegration properties and Granger causality on the relationship between population and per capita income in mainland China in a multivariate vector autoregressive model. This study finds the evidence of a common stochastic trend between population and per capita income which is indicative of long-run relationship between these two variables. Empirical results also indicate that a negative long-run causal relationship is flowing from per capita income to population. The short-run relationship between population growth and per capita income growth is at variance across model specifications. The neoclassical growth model reveals that population growth positively contributes to per capita income growth while the modified endogenous growth model shows a negative relationship between these two variables. Moreover, both neoclassical and endogenous growth models indicate that per capita income growth tends to lower the population growth. The long-run relationship is consistent with Becker's view that as income grows, families tend to prefer quality rather than quantity of children.

Extended generalized purchasing power parity and optimum currency area in East Asian countries

This article extends the theory of generalized purchasing power parity (G-PPP) by developing a model including foreign variables such as the real money supply, output and interest rate. A cointegration rank test with two structural breaks in the deterministic trend was adopted to selected Asian countries, with Japan as the base country. There were two cointegrating vectors and six common stochastic trends in the model. The cointegrating vectors were estimated by the same approach used by Pesaran et al. (2000). The first cointegrating vector is interpreted as G-PPP, and the second one is interpreted as the extended G-PPP. According to G-PPP, these countries could form a single currency area. The first stochastic trend is primarily driven by Japan's real money supply; the second, third and fourth by the real exchange rates of the Philippines, Singapore and Thailand, respectively; the fifth by Japan's output; and the sixth by Japan's government bond yields.

International Direct Real Estate Market Linkages: Evidence from Time-Varying Correlation and Cointegration Tests

This study examines the linkage between direct real estate markets in the UnitedStates, United Kingdom, Australia, Hong Kong, and Singapore from both the long-termand short-run perspectives over the period 1988–2008. The evidence indicatesno co-integrating relationship exists in over 80% of the direct real estate marketsystems. The absence of a long-run stable relationship implies the presence ofpotential gains from international diversification in direct property investing, as manymarkets /sectors move separately with no shared common stochastic trend. Moreover,the conditional return relationships between the five major real estate markets aretime-varying especially when the return series are inflation-adjusted. Finally, althoughthe short-term co-movements between many real estate markets are still very low,stronger return relationships among the five major real estate markets are present,implying that portfolio managers should expect some reduced diversification benefitsin the long run.

Is Moderate Market Performance in the U.S. a Sufficient Condition for Abnormal Returns on CEFs?

In this project, our topic pertains to examination of market efficiency, employing data from closed-end funds (CEFs) trading in the American stock market. Employing both aggregate and individual data, we examine whether or not moderate market performance is a sufficient condition in order to achieve abnormal returns, in the short-run, through exploitation of discount deviations from its mean value. The main hypothesis tested is that market performance affects the mean-reverting properties of CEFs’ discount. Moderate market performance ensures the mean-reversion of CEFs’ discount and points to cointegration between the share prices of CEFs and their net asset value (NAV). Furthermore, when NAV is identified as the common stochastic trend of the system then, market inefficiency is detected.

Struktura terminowa stóp procentowych na rynku depozytów międzybankowych w Polsce. Uwagi o symetrii powrotu stóp do średniej

The empirical analysis of the term structure of the Polish interbank rates has revealed that the short and the long rates from the whole spectrum of maturities have evolved almost accordingly to the expectations hypothesis. They have exhibited common stochastic trends, their spreads have had cointegrating properties as well as much predictive power. Off all WIBORs considered it is only a 3 month rate that has asymmetrically been reverting to the mean.