In EViews, open the 'currencies.wf1' file that will be...

Name: Problem 8, Chapter 7: Introductory Econometrics for Finance
Uploaded: 2021-04-13T01:07:16-08:00
Duration: 6 min 31 s
Channel: Heather Duong
Description: In EViews, open the 'currencies.wf1' file that will be discussed in detail in the following chapter. Determine whether the exchange rate series (in their raw levels forms) are non-stationary. If that is the case, test for cointegration between them using both the Engle-Granger and Johansen approaches. Would you have expected the series to cointegrate? Why or why not?

In EViews, open the 'currencies.wf1' file that will be discussed in detail in the following chapter. Determine whether the exchange rate series (in their raw levels forms) are non-stationary. If that is the case, test for cointegration between them using both the Engle-Granger and Johansen approaches. Would you have expected the series to cointegrate? Why or why not?

Key Concepts

Stationarity

Stationarity refers to the property of a time series where its statistical characteristics such as mean, variance, and autocorrelation structure remain constant over time. In time series analysis, establishing stationarity is crucial because most modeling techniques rely on the assumption that the underlying process does not change with time. Non-stationary series may exhibit trends, cycles, or other patterns that can lead to misleading inferences if not properly addressed.

Unit Root Testing

Unit root tests are statistical procedures used to determine whether a time series is non-stationary due to the presence of a unit root. Common tests such as the Augmented Dickey-Fuller (ADF) or Phillips-Perron tests help identify if a series requires differencing to achieve stationarity, which is a necessary step prior to many forms of time series analysis, including cointegration testing.

Cointegration

Cointegration is a concept in time series analysis where two or more non-stationary series are linked by a long-run equilibrium relationship, meaning that a certain combination of them is stationary even though the individual series are non-stationary. This property is particularly important in economics as it provides evidence that a group of variables move together over time, suggesting some underlying equilibrium forces are at play.

Engle-Granger Method

The Engle-Granger method is a two-step approach for testing cointegration between non-stationary time series. The first step involves estimating a long-run equilibrium equation and obtaining the residuals; the second step tests these residuals for stationarity. If the residuals are stationary, it indicates that the series are cointegrated, confirming the existence of a long-term relationship.

Johansen Approach

The Johansen approach is a multivariate method for testing cointegration that allows for more than one cointegrating relationship among a group of non-stationary variables. Unlike the Engle-Granger method, which is limited to a single cointegrating vector, the Johansen test is based on a system of equations and uses statistical techniques such as the trace test and maximum eigenvalue test to identify the number of cointegrating relationships.

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