DETECTION OF FUNCTIONAL FORM MISSPECIFICATION IN COINTEGRATING….pdfVIP

DEPARTMENT OF ECONOMICS UNIVERSITY OF CYPRUS DETECTION OF FUNCTIONAL FORM MISSPECIFICATION IN COINTEGRATING RELATIONS Ioannis Kasparis Discussion Paper 2007-05 P.O. Box 20537, 1678 Nicosia, CYPRUS Tel.: ++357-2-892430, Fax: ++357-2-892432 Web site: http://www.econ.ucy.ac.cy DETECTION OF FUNCTIONAL FORM MISSPECIFICATION IN COINTEGRATING RELATIONS IOANNIS KASPARIS University of Cyprus July 4, 2007 Abstract A simple speciÖcation test based on fully modiÖed residuals and the CUSUM test for cointegration of Xiao and Phillips (Journal of Econometrics, 2002) are considered as means of testing for functional form in long-run cointegrating relations. It is shown that both tests are consistent under functional form mis- speciÖcation and lack of cointegration. A simulation experiment is carried out to assess the properties of the tests in Önite samples. The Dickey-Fuller test is also considered. The simulation results reveal that the Örst two tests per- form reasonably well. However, the Dickey-Fuller test performs poorly under functional form misspeciÖcation. 1 INTRODUCTION Cointegration has probably been the most popular approach in analysing macroeco- nomic relations since it was introduced, about twenty years ago. Although the con- cept of cointegration is very appealing from an economic theory point of view, many data sets have failed to show evidence supporting the existence of long-run macroeco- nomic equilibria. Lack of evidence for cointegration in certain data sets has created doubts about the validity of the classical linear cointegration models and led some researchers to consider the possib