Tinbergen Institute Discussion Paper TI 2018-085/III
We consider the Fractional Vector Error Correction model proposed in Avarucci (2007), which is characterized by a richer lag structure than the models proposed in Granger (1986) and Johansen (2008, 2009). In particular, we discuss the properties of the model of Avarucci (2007) (FECM) in comparison to the model of Johansen (2008, 2009) (FCVAR). Both models generate the same class of processes, but the properties of the two models are different. First, opposed to the model of Johansen (2008, 2009), the model of Avarucci has a convenient nesting structure, which allows for testing the number of lags and the cointegration rank exactly in the same way as in the standard I(1) cointegration framework of Johansen (1995) and hence might be attractive for econometric practice. Second, we find that the model of Avarucci (2007) is almost free from identification problems, contrary to the model of Johansen (2008, 2009) and Johansen and Nielsen (2012), which identification problems are discussed in Carlini and Santucci de Magistris (2017). However, due to a larger number of parameters, the estimation of the FECM model of Avarucci (2007) turns out to be more complicated. Therefore, we propose a 4-step estimation procedure for this model that is based on the switching algorithm employed in Carlini and Mosconi (2014), together with the GLS procedure of Mosconi and Paruolo (2014). We check the performance of the proposed estimation procedure in finite samples by means of a Monte Carlo experiment and we prove the asymptotic distribution of the estimators of all the parameters. The solution of the model has been previously derived in Avarucci (2007), while testing for the rank has been discussed in Lasak and Velasco (for cointegration strength >0.5) and Avarucci and Velasco (for cointegration strength <0.5). Therefore our paper fills in the gap for a complete inference based on Avarucci (2007) model.
Error correction model Gaussian VAR model Fractional Cointegration Estimation algorithm Maximum likelihood estimation Switching Algorithm Reduced Rank Regression