This paper proposes an efficient test designed to have power against alternatives where the error correction term follows a Markov switching dynamics. The adjustment to long run equilibrium is different in different regimes characterised by the hidden state Markov chain process. Using a general nonlinear MS-ECM framework, we propose an optimal test for the null of no cointegration against an alternative of a globally stationary MS cointegration. The Monte Carlo studies demonstrate that our proposed tests display superior powers compared to the linear tests. In an application to price-dividend relationships, our test is able to find cointegration while linear based tests fail to do so.
We are grateful to Charlie Cai, Marine Carrasco, Thomas Fomby, Hans-Martin Krolzig, Peter Phillips, Werner Ploberger, Peter Schmidt, seminar participants at University of Kent, University of Leeds, Michigan State University, University of Montreal, Northern Illinois University, Wayne State University, and conference delegates at Advances of Econometrics Meeting in Honor of Peter C.B. Phillips at Southern Methodist University, Dallas, on November 1–3, 2013 for their helpful comments. The usual disclaimer applies.
Hu, L. and Shin, Y. (2014), "Testing for Cointegration in Markov Switching Error Correction Models", Essays in Honor of Peter C. B. Phillips (Advances in Econometrics, Vol. 33), Emerald Group Publishing Limited, Bingley, pp. 123-150. https://doi.org/10.1108/S0731-905320140000033005
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