TestingforCommon Trends

JAMESH. STOCK and MARKW. WATSON*

Cointegrated
multipletimeseriesshareat leastone commontrend.Two testsare developedforthenumberof common
drift.Bothtestsinvolvethe
timeserieswithand without
in a multiple
stochastic
trends(i.e., fortheorderofcointegration)
lag. Criticalvaluesforthe
theseriesontoitsfirst
matrix
obtainedbyregressing
leastsquarescoefficient
rootsoftheordinary
in a MonteCarlostudy.Economictimeseriesareoftenmodeledas havinga
andtheirpoweris examined
testsaretabulated,
a stochastic
trend.Butbothcasualobservation
as containing
or (equivalently)
representation,
unitrootintheirautoregressive
If each
trendsso thattheyare cointegrated.
containthesamestochastic
suggestthatmanyseriesmight
and economictheory
thenthevectorrepresentation
trends,
byk < n stochastic
ofn seriesis integrated
oforder1 butcan be jointlycharacterized
linearcombinations.
Ourproposedtestscanbe viewedalternatively
stationary
oftheseserieshask unitrootsandn - k distinct
or autoregressive
unitrootsofthevector
vectors,
cointegrating
linearly
independent
as testsofthenumber
ofcommon
trends,
thatcertain
The first
test(qf) is developedundertheassumption
similar.
process.Bothoftheproposedtestsareasymptotically
are
and thenuisanceparameters
vectorautoregressive
(VAR) representation,
of theprocesshavea finite-order
components
of a corrected
theeigenvalues
handledby estimating
thisVAR. The secondtest(q,) entailscomputing
samplefirst-order
a sumof theautocovariance
matrices.
Previousresearchers
have
is essentially
wherethecorrection
autocorrelation
matrix,
oforder1. In addition,thetheory
of the
appearto be integrated
foundthatU.S. postwarinterest
rates,takenindividually,
maturities
willbe cointegrated.
Applying
theseteststo postwar
termstructure
impliesthatyieldson similarassetsofdifferent
billratesprovidessupportforthisprediction:
treasury
U.S. data on thefederalfundsrateand thethree-and twelve-month
ratesappearto be cointegrated.
The threeinterest
processes;Multipletimeseries;Unitroots;Yield curve.
Factormodels;Integrated
KEY WORDS: Cointegration;

thatit has m < k commontrends.

againstthealternative
of
ofX, is integrated
It is assumedthateach component
of
combinations
k
linear
but
that
there
are
n
1,
order
(1987)
and
0.
Engle
Granger
of
order
are
integrated
that
X,
oforder(1, 1).
definedsucha processto be cointegrated
are a'X,, thenthe
linearcombinations
If the stationary
vectorsofX,.
columnsof a are termedthecointegrating
then
if
is
cointegrated,
that
showed
and
Granger
Engle
X,
in termsof an error-correction
it has a representation
model,as developedbySargan(1964),Davidson,Hendry,

1. INTRODUCTION

There is considerableempiricalevidencethatmany
macroeconomic
timeseriesare welldescribedbyunivarimovingaverage(ARIMA)
integrated
ate autoregressive
the data producesa seriesthat
models,so differencing
It has beenlessclear
appearsto be covariancestationary.
whattransformation
shouldbe appliedto data used in
models,since(looselyspeaking)thenumber
multivariate
ofunitrootsin a multiple
timeseriesmaybe lessthanthe
univarisumofthenumberofunitrootsintheconstituent
Srba, and Yeo (1978), and others.
series
althougheach univariate
ate series.Equivalently,
an oldernotion
formalizes
The conceptofcointegration
containa stochastic
trend,in a vectorprocessthese thatsomelinearcombinations
might
oftimeseriesvariablesaptrendsmightbe commonto severalofthevaristochastic
whereasothersappearto be almost
pear nonstationary,
ofthese
thenumber
evidenceconcerning
ables.Empirical
to thoselinearcomwhitenoise. Frisch(1934) referred
forseveralreasons.First,an binations
commontrendsis ofinterest
of timeseriesdata withverysmallvariancesas
economicor physicaltheorymightpredictthatthevari- beinggenerated
one ofhisprimary
by"trueregressions";
anda testforthesecommon concernswas withthe "multiplecolinearity"
ablescontaincommontrends,
thatarose
of thetheory.
trendswouldbe a testof thisimplication
(cointewhentherewas morethanone trueregression
thenumber grating
Second,one mightwishto imposeexplicitly
vector)amongthevectorofvariates.Box andTiao
Third,itmight (1977)associatedtheleastpredictable
ofcommontrendswhenmakingforecasts.
linearcombinations
be desirableto specify
a timeseriesmodelin whichall of (i.e., thosewiththeweakestserialdependence)of with
X,
butinwhichthedataare not
thevariablesare stationary,
theydescribed
relationships;"
"stablecontemporaneous
would occur
Such overdifferencing
"overdifferenced."
as characterizing
dy- ma
the mostpredictablerelationships
in termsof thefirstdifferences namic
werethemodelspecified
series.
to
all
of
the
common
growth
of the variables,becausethiswouldignorethe reduced
in
modelscan be represented
formally
Cointegrated
ofthecommontrends.
dimensionality
stochastic
of
common
number
trends,
termsof a reduced
thatan n x 1
We developtestsof thenullhypothesis
Forunivariate
or stationary,
components.
plustransitory,
trends,
stochastic
timeseriesvariableX,hask c n common
models,Beveridgeand Nelson (1981) showedthatany
identified
ARIMA processhasan exactly
integrated
singly
in
which
the
trendis
representation,
trendplustransitory
* JamesH. Stock is AssistantProfessorof PublicPolicy,JohnF. Kenis
covariance
component
a randomwalkandthetransitory
HarvardUniversity,
Cambridge,MA 02138.
nedySchool of Government,
Fountisand Dickey(1986) extendedthisdeMark W. Watson is Associate Professor,Department of Economics, stationary.
NorthwesternUniversity,Evanston, IL 60208. This researchwas supported in part by National Science Foundation Grants SES-84-08797,
SES-85-10289, and SES-86-18984. The authors are gratefulto C. Cavanagh,R. F. Engle, J. Huizinga, J. Patel, C. Plosser, P. C. B. Phillips,
R. Tsay, the referees,and an associate editorforhelpfulsuggestions.

1097

? 1988AmericanStatistical
Association
oftheAmericanStatistical
Association
Journal
and Methods
December1988,Vol.83, No.404,Theory

Joumal ofthe American StatisticalAssociation,December 1988

1098

of (2.1) yields
composition
to vectorautoregressive
(VAR) modelswith stitution
k = 1. In Section2, we providea generalrepresentation
Xt = XO+ ,ut+ C(l)G'112t+ C*(L)Gl/2vt, (2.2)
between
thesemodels,
fork c n. Becauseoftheequivalence
ourproposedtestsfork versusm commontrendscan be where C*(L) = (1 - L)-1(C(L) - C(1)) so that Cj* =
ofn - k versusn ofas testsfortheexistence
thought
Ci. Because a'C(l) = 0 and a'u = 0, it follows
-E'=j,I
that
vectors.
m linearly
independent
cointegrating
Severalspecialcasesofthistesting
problemhavebeen
(2.3)
a'Xt = a'Xo + a'C*(L)GlI2vt.
Zt
considered
elsewhere.
The case thathasreceivedthemost
in (2.1) thatC(L) is 1attention
has been testingfor1 versus0 unitrootsin a Withthe additionalassumption
summable
(Brillinger
1981),C*(L) isabsolutely
univariate
timeseries(e.g., see Dickeyand Fuller1979; summable
Fuller1976;Phillips1987;Solo 1984). In a multivariateand Zt has boundedvariance.
represetting,
a testof k = 1 versusm = 0 was developedby
The cointegrated
processXt has an alternative
in termsof a reducednumberof commonranFountisand Dickey(1986)forprocesseswitha VAR rep- sentation
resentation
withiid normalerrors.Engle and Granger domwalksplus a stationary
This "common
component.
is readilyderivedfrom(2.2). Be(1987) proposedand compareda varietyof testswhenn trends"representation
= k = 2 and the hypothesisof interestis k = 2 versusm cause C(1) has rankk < n, thereis an n x r matrix
H1
= 1. Liketheothertestsinthisliterature,
ifH2 is
ourtestisbased withrankr suchthatC(1)H1 = 0. Furthermore,
to
on therootsoftheestimated
autoregressive
representationan n x k matrixwithrankk and columnsorthogonal
thecolumnsof H1, thenA C(1)H2 has rankk. The n
of thetimeseries.
H = (H1 H2) is nonsingular
and C(1)H = (O
andcommon-trendsx n matrix
Section2 presents
thecointegrated
matrix[Okx(n-k)
ourtesting
representations
ofX,andsummarizes
strategy. A) = ASk,whereSkis thek x n selection
In Sections3 and 4, two testsof k versusm common Ik], whereOkx(n-k) is a k x (n - k) matrixof zeros.In
stochastic
trendsare proposedforthespecialcase thatXO addition,becausea'C(l) = 0 and a' = 0, ,ulies in the
= 0 andtheprocesshasno drift.
# = C(l),u,where
Thesetestsareextended columnspaceofC(1) andcanbe written
and drift
in ,uis an n x 1 vector.Thus(2.2) yieldsthecommon-trends
in Section5 to handlean estimated
intercept
forXt:
The asymptotic
valuesare representation
therelevant
regressions.
critical
tabulatedin Section6, and a smallMonteCarlo experiXt = XO+ C(l)[fit + G112Xt+ C*(L)Gl/2vt
mentinvestigating
the size and powerof thesetestsis
reportedin Section7. The testsare appliedto data on
= Xo + C(1)H[H-1it + H-IG12Xt] + at
ratesin Section8, and ourconclupostwarU.S. interest
= Xo + ATt + at,
Tt = 7r + Tt-1 + Vt,
(2.4)
sionsare summarized
in Section9.
whereat = C*(L)Gl/2vt,cTt= SkH lft + SkHG 1/2Xt,ir
= SkH-l'/,and vt = SkH-1G"12v,.[For a different
deriLet X, denotean n x 1 timeseriesvariablethatis vationofthecommon-trends
(2.4) andfurrepresentation
of order(1, 1). Thatis, each elementofX, therdiscussion,see King, Plosser,Stock,and Watson
cointegrated
ofX,that (1987).] The common-trends
is integrated,
buttherearerlinearcombinations
expressesXt
representation
of Engle and as a linearcombination
are stationary.
We workwithan extension
of k randomwalkswithdriftn,
thatallows plus sometransitory
of cointegration
Granger's(1987) definition
components,
at,,thatare integrated
forpossibledriftin X,. The changein X, is assumedto oforder0.
havethecointegrated
vectormovingaveragerepresenta- The common-trends
providesa converepresentation
tion
inwhichto motivate
ourproposedtests.
nientframework
thecomplications
thatarise
asideforthemoment
Putting
in
(2.2),
a natural
and
time
trend
intercept
from
a
nonzero
j + C(L)et,
AX=
(2.1)
E jjCj <00,
trends
k versusm commonstochastic
approachto testing
j=1
wouldbe to examinethefirst-order
serialcorrelation
mawhereC(z) = X,=oCiziwithC(0) = In(then x n identity trixofXt.BecauseXtis composedofbothintegrated
and
matrix),et is iid withmean 0 and covariancematrixG, L nonintegrated
however,its estimatedfirstcomponents,
is thelag operator,and A 1 - L. C(1) is assumedto orderserialcorrelation
matrix
limiting
has a nonstandard
haverankk < n, so X, is cointegrated;
thatis,thereis an distribution
thatgenerallydependson nuisanceparamn x r matrixa (where r = n - k) such thata'C(1) = 0 etersin complicated
thisdifficulty
we
ways.To mitigate
and a'p = 0. As Engle and Grangerpointedout, this examinefunctions
ofa lineartransofregression
statistics
ofAX,atfrequency formation
matrix
ofXt,denotedby Yt,chosenso thatunderthe
impliesthatthespectral
density
0, (2r)-1C(1)GC(1)', is singular.The columnsof a are nullhypothesis
the firstn - k elementsof Ytare not
thecointegrating
vectorsofX,.
whereasthefinalk elementsof Ytcan be exintegrated,
A representation
forthestationary
linearcombinations pressedin termsofthek separatetrends.Moreprecisely,
and let Y, = DX,, whereD = [a at]', whereat is an n x k
a'Xt is readilyobtainedfrom(2.1). Let vt= G-112et
chosenso thatat'a = 0 and at?at
adopttheconventional
assumption
(e.g., matrixof constants
Xf= zslVs
Dickeyand Fuller1979)thates = 0 (s < 0), andallowXt 'k. The firstn - k elementsof Y,are Z, in (2.3). Let W,
to havea nonrandom
initialvalueXO.Thenrecursive
sub- denotethe finalk integrated
elementsof Y,. It follows

2. THEMODELAND TESTING
STRATEGY

1099

Stock and Watson: Testing forCommon Trends

THE DATA
3. A TESTBASED ON FILTERING

from(2.1) that

inwhichthenuisance
a teststatistic
Thissectionpresents
by assuminga
of theprocessare eliminated
parameters
whereu, = C(L)vt, withC(L) = at'C(L)G112. Combining
Wt.
fortheprocessgenerating
representation
parametric
(2.3) and (2.5),
ofthistestparallelsDickeyandFuller's
The development
fora unitrootin a univariate
(2.6)
(1979) approachto testing
AkYt = ( + F(L)vt,
supposethatAW,has a finitetimeseries.Specifically,
where
so that(2.5) can be rewritten
orderVAR representation
as
(2.5)

AW, = att' + U,

Ak

[Ik

AIk]

FL=[aPC*(L)G
= [C C-o
F(L)

a-

H (L)AW, = Y + ?7,

(3.1)

of knownorderp
lag polynomial
whereH(L) is a matrix
withall rootsoutsidetheunitcircle,qais iidwithmean0,

1/21

of (2.6) showsthatYtcan be rep- and H(O) is normalizedso thatEq,q' = Ik. In thissection

Recursivesubstitution
it is assumed that WO= y = 0.
resentedas
First,supposethatD andH(L) are knownandlet t =
=

+[OC(n1)x]
=

a+

/32t+

LO( -k)x1
+[a

IH(L)Wt. Under (3.1), H(L)AWt = A[H(L)Wt] = t7,so

C*(L)G

latt+ /h(L)vt,

(2.7)

areranofHI(L)Wt
theelements
underthenullhypothesis
of m < k
underthe alternative
domwalks.In contrast,
of HI(L)Wtare rancommontrends,onlym components
areintegrated
elements
domwalks,whereastheremaining
fork versusm common
testing
of order0. Thissuggests
the rootsof the firstsampleautotrendsby examining

whereC*(L) = (1 - L) -1(C(L) - C(1)).

correlationmatrixformedusingSt,
In termsof Wt,a testof k versusm commontrends
becomesa testof whetherC(1) has rankk againstthe
theproposed
tha ithas rankm. To motivate
alternative,
(Pf,we have
tests,supposethatXO =,uh= 0, and considerthe result Rewriting
of regressing
Wtonto Wt1. Underthe nullhypothesis,
(3.2)
T[1f - Ik] = TkT(FkT),
sos,
ofk integrated
Wtis a linearcombination
processes,
wherePkT = T-1 I (t-ji7a and FkT = T2 E(t_1limitof
theprobability
behaviorofTkT and FkT has been treated
The limiting
= ][>3 Wac1Wonide-1,(2.8) intheunivariate
t
case by(forexample)White(1958),Solo
=[t
WW'
case
(1984), and Phillips(1987), and in themultivariate
Wtincludesm byPhillipsand Durlauf(1986)andChanandWei (1988).
has k realunitroots.Underthealternative
variablesand k - m nonintegrated
integrated
variables, Theserandommatrices
of
weaklyto functionals
converge
cointe- the k-dimensional
orequivalently
independent
Wthask - mlinearly
WienerprocessBk(t): FkT > =k
PDhas onlym
vectors.Thusunderthealternative
grating
foBk(t)Bk(t)'dtand tkT > Akk fo Bk(t)dBk(t)', where
variuniteigenvaluescorresponding
to them integrated
on thespaceofcontinuous
=> denotesweakconvergence
withmodulus(andtherefore functions
ables,andk - meigenvalues
(1968).Thus
on [0, 1]k inthesenseofBillingsley
withreal parts)less than1. Lettinglm,+1 denotethe ei- from
that
IkI
-1;
is,
T[.:f - 1k]
(3.2), T[1f
a> PkF
real part,our converges
genvalueof P withthe (m + 1)th-largest
weaklyto a randomvariablethathas thesame
null and alternativehypothesesare Ho: real(Am
+1) = 1
as Tkk-1. It followsthatT(Af - i) 4> A.,
distribution
versusH1: real(i{m+)< 1.
whereA. denotesthe vectorof orderedeigenvaluesof
of 'P when'P has Tk'kL , Afdenotesthe vectorof orderedeigenvaluesof
Muchis knownabouttheproperties
someunitroots.Whenn = 1 and utis seriallyuncorre- (Df,and i= (11
1)'.
studied
byWhite(1958),Fuller
lated,1 hasthedistribution
could be
If D and H(L) were knowna teststatistic
(1987) constructed
(1976),DickeyandFuller(1979),andothers.Phillips
D andH(L)
however,
usingif. In applications,
of T(Q - 1) underlessrestric- are typically
examinedthedistribution
can be remedied
unknown.This deficiency
on theerrors;thisanalysiswasgeneralized byusingestimators
tiveconditions
D and 1(L) of D and H(L), respeccase by Phillipsand Durlauf(1986). tively.Forthemoment,
to the multivariate
assumethatD andrI(L) existand
whenutis seriallycorrelatedthe distri- that (a) D -P> RD under both Ho and H1, where R =
Unfortunately,
i. dependson theautoco- diag(R1,R2), whereR1 and R2 are, respectively,
butionof'P and itseigenvalues
nonsinvariancesof ut.This dependencemakesit impossibleto gular(n - k) x (n - k) and k x k matrices
underthe
based null and (n - m) x (n - i) and
criticalvaluesof a statistic
tabulatetheasymptotic
k
kx
matricesunder
this thelalternativ,nd (b) H(L) and R2H(L)R ic
forcircumventing
on A in a practicalway.Strategies
underHo.
similartestsare Let Wt = SkDXtandSt = Hl(L)1. Thenone couldconproblemand developingasymptotically
in Sections3 and 4 forthecase (/h= 0, /12 =
presented
leastsquares(OLS) estimator
sidertheordinary
0, /12 = 0) and (/h
0) and are extendedto thecases(IA#&
# 0, /2 # 0) inSection
5.

1100

Journalof the American StatisticalAssociation,December 1988

covariancematrixensures
This modified
versionof (F, computedusingthefiltered an identity-contemporaneous
R2Hi(L)R-1.
series(t, has a limiting
in whichthenui- that1(L)
representation
in(3.1) do notappear.Letting
thatthere
sanceparameters
Thistestis consistent
againstthealternative
Afdenote
thevectoroforderedeigenvalues
of(Df,we haveTheorem arem ratherthank commontrendsusingeitherestimator
3.1.
oforder
ofrl(L), eveniftheprocessis notautoregressive
with
m
vectors.
n
p
but
satisfies
(2.1)
cointegrating
3.1. SupposethatD P RD, W,is generated
Theorem
the
DA
comUnder
alternative,
(constructed
using
principal
by (3.1) withW0 =y = 0, H(L) - * R2HI(L)R-1, and maxi
to
some
matrix
the
in
ponents)
converges
probability
Da,
- Ik) > R2*'TkF1R2j1,
E(i)
C /4 < oo. Then, (a) T((
vectors
which
contain
the
first
n
m
rows
of
cointegrating
(b) T(Af- i) a> A., and (c) T(IAfI- i) 4>real(A.).
to the
Proof. At the suggestion
of the editortheproofsof ofX, and thefinalm rowsofwhichare orthogonal
In
under
the
alternative
vectors.
cointegrating
addition,
alllemmasandtheorems
areomitted
butprovided
inStock
matrixlag polyJt(L) convergesto some (finite-order)
and Watson(1988).
nomial11a(L) evenifAW,does nothave a VAR(p) repTheorem3.1 suggeststestingfork versusm common resentation.
of A,At
From(2.1) and the definition
trends-orequivalently
fork versusm realunitrootsin
A
I(L)
Ha(L)
and
,
where
D5A
Da. Since
l(L)SkIC(L)eW
(D-usingthestatistic
has
finite
and
is
summable
order
rIa(L)
C(L) absolutely
underboththenulland thealternative,
HIa(L)SkDaC(L)
q f(k, m) = T[real(Af
m+1)- 11,
thealternaunder
is
absolutely
summable.
Furthermore,
where Af,m+1
is the (m + 1)th elementof Af.Under the
<
m'
rank(C(1)) = m < k.
nullhypothesis,
fromTheorem3.1(b) qf(k, m) asymp- tive,rank(HIa(1)SkDaC(1))
a
like
it
can
be shownthatas
Using construction (2.6),
totically
has thesamedistribution
as real(.*m+,).
St[and,by theconverThe construction
of qf requiresthe estimation
of RD thesamplesize tendsto infinity,
unit
of
rootsin itssample
and theautoregressive
matrixpolynomial
HI(L) in (3.1). gence H(L) and D, (t] has m'
- m' rootsless
k
and
matrix
autoregressive
The n x n matrixRD can be estimated
in a varietyof first-order
withrealpartsthatare
ways.The firstn - k rowsof D (and thusofRD) are a than1 in modulusand therefore
- 1 convergesin
1.
less
than
In
particular,
real(f,m+')
basisforthespace spannedby thecointegrating
vectors
so thetestis consistent.
to a negativenumber,
of X, underthe null. Because the cointegrating
vectors probability
obtains
whetherthe filteris
that
a
test
Note
consistent
formlinearcombinations
ofX,thathaveboundedvariance
thattheorder
or
assuming
estimated
either
using
AWt
uAt,
fromtheotherwise
integrated
elementsof Xt,they(like
of
the
fixed.
filter
is
the autoregressive
coefficient
in the univariate
unit-root
problemor itsmultivariate
analog,discussedin thepre4. A TESTBASED ON CORRECTINGTHEOLS
cedingsections)can be estimatedconsistently
without
AUTOREGRESSIVE
MATRIX
a particular
specifying
parametric
processforthe additestsfork versusk - 1
Our secondproposedstatistic
tionalstationary
As demonstrated
components.
in Stock
a
versionof P, thesample
common
trends
corrected
using
(1987,theorem
2), ifX, has therepresentation
(2.1) with
matrix
forWtin (2.8), under
autocorrelation
K
first-order
n - k cointegrating
vectorsand maxiE(84) < ??,
=
=
0
in (2.7). In thiscase,
that
the
assumption fl, fl2
thenthe cointegrating
of thecolumns
vectorsconsisting
(P
a
the
asymptotic
representation
giveninLemma4.1.
of can be estimated
by contemporaneous
OLS regres- has
sionsofone elementofXton theothers,afteran arbitrary Lemma 4.1. If maxiE(v4t) - /U4< ?oand = fl2 = 0
/l
normalization
to ensurethattheestimates
are linearly
in- in (2.7), then
dependent.
We adopta modification
ofthisapproach,inwhichthe T(&P - Ik) [C(1)PnTC(Q)1 + M'I[C(1)rnTC(Q)111
vectorsare constructed
cointegrating
to be orthonormal
A 0,
withthefirst
vectorforming
thelinearcomcointegrating
and M =
E
binationof Xt havingthe smallestvariance,the second where 'nT = T-1 I 't_lVt', Via =
1Eutjut'.
vectorhavingthenextsmallest
cointegrating
variance,and [,7o (C, - C,)q + (l)C(1)'] =
so on. Implementing
thisproceduresimplyentailsestiThis lemma indicatesthat T(Q - Ik) asymptotimatingtheprincipal
ofXt; a is estimated
components
by cally consistsof two parts.The first,[C(1)$nTC(1)']'
thoselinearcombinations
to thesmallest
n [C(1)FnTC(1)'iI1,is T timestheerrorin theestimateof
corresponding
- k principalcomponents,
and a' is estimatedby the (P obtainedbyregressing
therandomwalkC(l)4t ontoits
linearcombinations
to thelargestk prin- laggedvalue. The second,M'[C(1)rnTC(1)'I1,
corresponding
is analocipalcomponents.
Sincea consistently
estimates
thecoin- gousto theO(T-1) bias in contemporaneous
regressions
tegratingvectorsup to an arbitrarylinear transfor-of cointegrated
variables.This bias arisesfromthe cormation,D 4 RD = [aRl a'R']' forsomeR1and R2.
relationbetweentheregressor
Wt-1and utin (2.5). This
_4 Ik under the null [where (
=
Since (
termis relatedto the bias in OLS regression
estimates
&'1( Wt_1W)t-j-11,
z Wt
theparameters
ofR2lH(L)R1-l whentherearestationary
laggeddependent
variablesand
can be estimated
consistently
bya VAR(p) regression
us- seriallycorrelated
errors.In thepresentcontext,
sinceu,
ingeitherAIVWt
or it, whereui, are theresiduals
froma is notintegrated
(butis seriallycorrelated)
and W,is interegression
ofWtontoWt1. In eithercase,normalizing
the grated,thiscorrelation
producesnotinconsistency
buta
VAR coefficient
matrices
so thattheVAR residualshave component
of P thatis Op(T-1).
-

1101

Stockand Watson:TestingforCommon Trends

sinceitspresencemeans utut';. ThenM can be estimated

ThebiastermM isproblematic,
by
thatthedistribution
of (F (and its eigenvalues)depends
I
thelimiting
repon M and thuson C(L). Nevertheless,
M
(4.1)
K( )Vill
a solutionto thisprobresentation
inLemma4.1 suggests
j=1
(F usingan estimator
of
lem: ModifytheOLS estimator
whereK(j) is a (timedomain)kernel.For a proofofthe
distribution
of theeigenvalues
M so thatthe asymptotic
case forK(j) = 1 and
ofM in theunivariate
consistency
dependsonlyon r, and
of themodifiedOLS estimator
J = o(T1'4), see Phillips(1987).
tn.
This approach generalizesto the multivariate-setting
if M A
The testbased on q,(k, k - 1) is consistent
Phillips(1987,theorem5.1) testfora singleunitrootin
whereut = Wt- Wtu underthealternative,
Y271
Eu,1j
a univariate
wereW,observedand
process.Specifically,
write': = QAQ1 under
thisconsistency,
To demonstrate
M known,a corrected
by
estimator
(C couldbe computed
withtheroots
whereA is a diagonalmatrix
thealternative,
offthetroublesome
subtracting
term:
of 1 on the diagonalso thatthe firstk - 1 diagonal
, = [T-2 WtW>_2T-1M'][T-2
E Wt-W>]
1.
E
elementsare 1 and the finalelementis less than 1 in
ofeigenvectors
modulus,andwhereQ is thek x k matrix
Letting)c denotethevectorofthek orderedeigenvalues of(D. Underthealternative,
thelastelementofthetransof (Fc, we have Lemma 4.2.
process.
formedvariateQWt[say(QWt)kIis a stationary
and
autocorrelation
the
jth
(w)
denote
and
Let
pj
f(QwI)k
Lemma4.2. Let fl by a k x k matrixsuchthatflQQ'
A
respectively.
of
density
spectral
the
(scalar)
(QWt)k,
ofLemma4.1,
C(1)C(1)'. Then,undertheconditions
(1988)
Watson
and
Stock
in
techniques
the
using
calculation
I
(a) T(Q:c - Ik) 4 frr- lFj- and (b) T(ic - i) c A*
showsthatunderthefixedalternative,
Ack A 1 - (1 E
+
Because
= c(1 + 2 E
f(Qw,)k(O)
pP) Alck.
to Lemma4.2, thedistribution
of thestan- Plt)(l
According
c
positiveconis
a
(where
0
>
alternative
the
under
pj)
dardizedeigenvalues
of(Dcdo notdependon anynuisance
: - I, SO 2ck C 1 - 2(1 - pl)2 < 1 for Ipl(
El
stant),
pj
parametersand thuscan be tabulated.But (bc cannotitself
formthebasisfora testbecauseit involvesWt,whichis <1. Thus T(iCk - 1) tendsto -oX underthefixedalterthatthetestis consistent.
notdirectly
observed,andM, whichdependson unknown native,demonstrating
termM
of thecorrection
estimators
candidate
all
Not
As we discusslater,however,M can be esparameters.
that
suppose
In
particular,
test.
in
a
consistent
result
AWt
ofM, M, is suchthat
timated;supposethattheestimator
M
that
so
estimator
an
iS
to
construct
than
used
Ua
rather
M AP R2MR2. Let Y1= DXI, and use W, = SkYtand M
to formthe analog of (bc,

MAP-

I E[A Wt_jAW'W]
underboththe nulland thefixed

usingM and
alternative.
Underthenull,thetestsformed
D = [T2 >E W - T-'M'I[T2
I
equivalent.Underthe alternative,
M are asymptotically
usingM, DcA Ik, so in particular
however,ifcorrected
The consistency
of D and M ensurethattheeigenvalues
p 1 and a one-sidedtestbased on thisrootis
real(Ac{k)
of(DC,AC,are asymptotically
equivalent
to theeigenvalues notconsistent.
of$C.
AA

Theorem4.1. Suppose that D P RD and M p

ofLemma4.1, (a)
R2MR'. Then,undertheassumptions
T((Dc - Ik) 4 R2fIPrk-1f'-1R-1 and (b) T(Q, - I) 4

5. MODIFICATIONSFOR ESTIMATEDINTERCEPTS
AND DRIFTS

In practiceit is desirableto allowfornonzeroXO,and

modelmightbe
a moreappropriate
in manyapplications
as
a cointegrated
drift
as
well
nonzero
has
a
oneinwhichX,
Part(a) of thistheorempresentsa limiting
represen- stochastic
the
addresses
This
section
problemof
structure.
tationforthe orderedeigenvaluesof (Dc. We therefore testing
is
of
rank
that
the
k, against
null
C(1)
the
hypothesis
definetheteststatistic
and
the
when
<
k
it
is
m
intercept
that
the alternative
this
entails
of
In
terms
testing
(2.7),
drift
maybe nonzero.
qj(k, k - 1) = T[real(Ac,k)- 1],
thattherankof C(1) is k versusm wheneither(a) fi2 =
or (b) fi,
whereAc,kis the kthelementof Ac.Underthe nullhy- Obutfi,mightbe nonzero(butis nonrandom)
In case
be
nonzero.
both
but
pothesis,qj(k, k
1) convergesto the real partof the andfi2 arenonrandom might
that
are
combinations
k
linear
has
(b) underthenullXt
T'rL-1
smallesteigenvalueoftherandommatrix
under
the
alwhereas
The construction
of theqc statistic
requiresestimators randomwalkswithnonzerodrifts,
In
a
univaricombinations.
linear
of D was discussedin Section3. ternative
D and M. Construction
Xthas m such
dataareoftenmodeledas stamacroeconomic
forM in Lemma4.1 suggestsan ate setting
The secondexpression
nonzeromean;
a constant
around
differences
infirst
ofthek tionary
ofM basedon thesamplecovariances
estimator
this
x 1 vectorofresidualsut= Wt- (Wt 1 fromtheregres- as BeveridgeandNelson(1981)showed, impliesthat
as thesumof a randomwalk
ofM is clearlyrelated theprocesscan be written
sionofW,ontoW_1&.
The estimation
component.
a
and
mean-Ostationary
to theproblemof estimating
thespectraldensitymatrix withnonzerodrift
fit
thisunivariboth
generalizes
fi2
be
nonzero
of ut at frequency
0, (2ir)-1 ,__ Vj = (2rr)'(Vo + M Letting and
testpermits
case
and
multivariate
to
the
ate
specification
+ M') (whereVj = Eu,utt ), so techniques
developedfor
up
in
which
alternative,
an
against
trends
ingforcommon
its estimation
can be appliedhere.Let V. = T'1 StT=

A*.*

1102

Journalofthe American StatisticalAssociation,December 1988

to n - m components
are stationary
arounda lineartime and
trend.Fora discussion
ofthemacroeconomic
implications
-2 E Wt
dIr = [T-2 E WTWT'
ofstochastic
versusdeterministic
trendsineconomictime
series,see Nelsonand Plosser(1982); foran alternative The treatment
of
of 41P and bT parallelsthetreatment
approachinwhichthedrift
in thestochastic
trendis itself 1 in Section4. It is firstshownthatthe asymptotic
dismodeledas a randomwalk(so thattheseriesis stationary tributions
of P, ?P, and Vr dependon thesamenuisance
onlyaftertakingseconddifferences),
see Harvey(1985). parameters,althoughthe randomcomponentsin the
WefollowFuller's(1976)andDickeyandFuller's(1979) asymptotic
Thismakesit possible
differ.
representations
univariatetreatment
of intercepts
and timetrendsand toconstruct
matricesI)Pand )r,theeigenvalues
corrected
thepreviousteststatistics
modify
so thatan intercept
or of whichhave a distribution
of the
thatis independent
an intercept
and a driftare estimated.Accordingly,
let nuisanceparameters.
Ytl = Yt - T
Ytand Yr =Yt - fi1- fl2t, where/,h
and fl2 are the OLS estimatesof Il and fl2 obtainedby
Lemma5.1. SupposethatmaxiE(vit) c u4 < ??. (a) If
regressing
and t,and let Wt = SkYt and
Yton a constant
0
is an arbitrary
constant,
then
to thefiltering
testentails fl2 = in (2.7), andf?l
Wt= SkYT.The modification
estimating
the autoregressive
polynomial
H(L) usingWt
I)
[C(1)nTQC(1)Y + M'I[C(1)rfTC(1) I1 -4 0.
T(
or WtT
ratherthanWt(as inSec. 3). Let = R
H(L) Wtand
then
constants,
(b) If/,and/12 in (2.7) are arbitrary
t = H(L)WtT, and define
40,
i)
[C(1)Pt'TC(1)' + M'I[c(1)r,TC(T)QI1
(4)y

- [E

ct-1ct8 1]1

t Ct8-l

and

Or

Let TI

foBi(t)

(MItt

24tr
( l (T]-

dBi(t), rF

11

f0 Bk (t)B (t)' dt,

f1Br(t)Br(t)' dt,where
foBk(t) dBk (t), and T f
B8(t) = Bk(t) - fo Bk(s) ds and BT(t) = Bk(t) ds - t f a2(s)Bk(s) ds, where al(s) = 4 f a(s)B(s)
6s and a2(s) = -6 + 12s. Also, let Ay,Ai,A)*,and A*,
respectively,
denotethe orderedeigenvaluesof I l,4?,
tIP'(Fl)-t, and PT'(F)-T) We nowhaveTheorem5.1.
=

T1
T
2 'P- 15A , FnT

whereAPT

T-1 2 (T 5T

T =

T1/20OT and

T
=T32

St=1
- 6(tlT), and a2t

0iT

and F"T

T-2 2 ,p,8

T~T',where

T1/2E1T -

T-1/202Tt, where

(i = 0, 1, 2), withaot= 1, alt

- 6 + 12(tlT).

'rnT

dependon M, givenin
representations
These limiting
by corLemma4.1. This dependencecan be eliminated
~~~~~~~~~~~~~A
ofM, M, as suggested
(b and4YTusingan estimator
recting
in Section4. In addition,sinceD and therefore
Wtare
-

unknown,replace WtwithWt= SkDXt. Accordingly,let

1
(DP= [TW8Wv
1- T-1M'][T-2 Ml_ Wr 1]
A

5.1. SupposethatD -P RD, Wtis generated

Theorem
and
< j4 < ??
by (3.1), I(L) 4 R21(L)R2r, and max E(1)
1
(a) If = 0 and W0is an arbitrary
constant,then(i)
E
(DC = [T-2 E WtVWvl- T-1_][T-2
T((Dj - Ik) a R2APk'(FO)-1R-1, (ii) T(Iy - i) a A;*,and
denotethevectorofordered
(iii) T(IAy- i) > real(/*)).(b) If yand W0are arbitrary andletAlandATrespectively,
of eIYand eIT.We nowhaveTheorem5.2.
eigenvalues
constants,then(i) T(4Dr - Ik) > R2'' (Frk)- 1Rr-1, (ii)
) > real(AT).
T(i) > Ar,and (iii) T(I)4-r
r

The counterparts
of qf(k, m) whentheremightbe a
nonzerointercept
or a nonzerointercept
and drift
are
qy(k,m) = T[real(Iym+i) - 11
and

Theorem5.2. Suppose that D P RD, M 4 R2MR2,

and the assumptionsof Lemma 5.1 hold. (a) If f2 = 0 in
then(i) T(PDY- I)
constant,
(2.7) and f1is an arbitrary
# R2

'(Fk)lfl

- R -1, (ii) T(A4

i)

a ll, and (iii)

real()A). (b) Iff,landfl2in(2.7) arearbitrary

constants,then (i) T(4T - I) a R2Q1k'(Fk)
2
- i) i real(AT).
(ii) T( AT- i) a Ar, and (iii) T(IACI
T(I)A1- i)

qT(k,m) = T[real()4m+A)- 11,

teststatistics
makesitpossibletoconstruct
have the same limiting
distribution Thistheorem
which(respectively)
an estito
k
for
either
1)
accounting
analogous
qc(k,
underthe null as real(i.A/m+t)
and real(iAm+t),
where
mated
or
an
estimated
and
The
drift.
intercept
intercept
eigenvalueof FDy,and so
AY,m+tis the (m + 1)th-largest
comare,
respectively,
modification
is
that
the
tests
only
on.
The modification
to theq, statistic
fora nonzerointer- putedusingdeviationsof Wtaroundits averageor the
of Wtontoa constantand a
cept or driftproceedssimilarly.
Suppose thatD were residualsfroma regression
linear
time
trend.
Therefore,
let
known,let YH = Yt - T-1 I Ytand Yr = Yt - fit- fl2t,
fit
where andfi2 arethecoefficients
fromregressing
Y onto
qP(k, k - 1) = T[real(A',k) - 11
Wa = SkYe
Wth
SkYc.
and
=
By analogyto
(1, t). Let
A,define
and
?#= [T-2 E W#tt]T2

8l8l

qc(k,k

1)

T[real(/Ick)

11]

1103

Stock and Watson: Testing forCommon Trends

Table 1. Quantiles of real(1*)
Eigenvalue number

Significance
level

1%
2.5%
5%
10%
15%
50%
90%
95%

-13.8
-10.6
-8.0
-5.6
-4.36
-.87
.94
1.30

1%
2.5%
5%
10%
15%
50%
90%
95%

-6.7
-5.1
-3.78
-2.71
-2.10
-.21
1.15
1.50

-24.4
-20.4
-17.5
-14.3
-12.3
-5.8
-1.30
-.62

1%
2.5%
5%
10%
15%
50%
90%
95%

-4.24
-3.23
-2.53
-1.82
-1.4
.02
1.24
1.58

-15.0
-12.9
-11.1
-9.2
-8.1
-3.97
- .56
-.08

-34.6
-29.7
-26.0
-22.2
-19.9
-11.6
-4.97
-3.83

1%
2.5%
5%
10%
15%
50%
90%
95%

-3.19
-2.5
-1.95
-1.4
-1.07
.14
1.29
1.62

-11.5
-9.9
-8.5
-7.2
-6.4
-3.13
- .21
.20

-22.6
-20.1
-18.0
-15.6
-14.1
-8.4
-3.57
-2.74

-43.3
-38.3
-34.4
-30.0
-27.2
-17.5
-9.4
-7.8

1%
2.5%
5%
10%
15%
50%
90%
95%

-2.67
-2.04
-1.64
-1.17
-.88
.22
1.32
1.66

-9.6
-8.3
-7.2
-6.1
-5.5
-2.66
-.02
.36

-18.3
-16.1
-14.5
-12.6
-11.4
-6.9
-2.93
-2.25

-30.1
-27.1
-24.7
-22.0
-20.2
-13.4
-7.3
-6.1

-51.6
-46.2
-41.9
-37.4
-34.5
-23.6
-14.1
-12.3

1%
2.5%
5%
10%
15%
50%
90%
95%

-2.25
-1.75
-1.40
-1.00
-.74
.28
1.36
1.69

-8.3
-7.3
-6.4
-5.4
-4.84
-2.28
.13
.49

-15.5
-13.8
-12.4
-10.9
-9.9
-6.0
-2.5
-1.89

-24.5
-22.3
-20.4
-18.2
-16.8
-11.3
-6.2
-5.3

-38.1
-34.3
-31.5
-28.3
-26.3
-18.6
-11.4
-9.9

Dimension
of A.

-60.2
-54.6
-49.8
-44.8
-41.7
-29.7
-19.1
-16.8

where l,4k (or Ac,k) is thekth-largest

eigenvalueof IP (or of therealpartof thesmallestrootof kTFkkT1,whichin
the
as real(A*,J,
distribution
eF").Theorems5.1 and 5.2 implythatunderthenullhy- turnhasthesameasymptotic
pothesisqy(k,m) > real(Iu,m+),
q"(k, m) > real(iI*m+), realpartofthesmallestrootofT'VF-1.Theorems5.1 and
q1(k, k - 1) > real(A/*k), and qc(k, k - 1) > real(IAVk). 5.2 implythatsimilarremarksapplyfortheq/, q", q',
ofthe
thedistributions
Accordingly,
andq" teststatistics.
and
of
roots
ordered
the
of
1,
real
parts
Pk'TkT
Pkt(FTkT)
6. CRITICALVALUES
A

AyT(F

'IT)- were computedusing30,000Monte Carlo rep-

do licationswithT = 1,000.(As a checkof whetherT =

Althoughthepreceding
asymptotic
representations
large,thek = 3 entriesin thetables
notprovideexplicitdistributions
oftheproposedteststa- 1,000is sufficiently
withT = 2,000.
using10,000replications
forcomputing wererecomputed
tistics,
theydo suggesta simpleprocedure
werenegbetweenthetwodistributions
the asymptotic
distributions
using Monte Carlo tech- Thediscrepancies
niques.Forexample,fromTheorem3.1 (b) andTheorem ligible.)
of real(X*1)are
4.1 (b), theasymptotic
distributions
of qf(k,k - 1) and
Selectedquantilesof the distribution
=
and
j = 1,...,
6
.
.
.,
1,
k
1
for
in
Table
tabulated
distribution
qc(k,k - 1) are thesameas theasymptotic

Journalof the American StatisticalAssociation,December 1988

11104

Table2. Quantilesofreal(AlJ
Dimension
ofA;

Significance
level

number
Eigenvalue
1

1%
2.5%
5%
10%
15%
50%
90%
95%

-20.6
-16.8
-14.1
-11.2
-9.5
-4.36
-.82
-.1 1

1%
2.5%
5%
10%
15%
50%
90%
95%

-12.3
-10.3
-8.8
-7.2
-6.2
-3.03
-.29
.33

-30.9
-26.4
-23.0
-19.5
-17.2
-9.7
-4.05
-3.10

1%
2.5%
5%
10%
15%
50%
90%
95%

-9.1
-7.9
-6.8
-5.7
-4.99
-2.53
-.07
.53

-20.1
-17.7
-15.7
-13.5
-12.1
-7.1
-2.91
-2.19

-40.2
-35.4
-31.5
-27.3
-24.8
-15.6
-8.1
-6.8

1%
2.5%
5%
10%
15%
50%
90%
95%

-7.6
-6.6
-5.8
-4.91
-4.33
-2.33
.04
.64

-15.9
-14.1
-12.6
-10.9
-9.9
-5.8
-2.35
-1.73

-27.7
-24.8
-22.5
-19.8
-18.2
-11.9
-6.3
-5.3

-49.2
-43.6
-39.3
-35.0
-32.1
-21.6
-12.7
-11.0

1%
2.5%
5%
10%
15%
50%
90%
95%

-6.7
-5.8
-5.2
-4.45
-3.94
-2.05
.13
.75

-13.5
-12.1
-10.8
-9.5
-8.6
-5.1
-2.02
-1.43

-22.7
-20.3
-18.4
-16.5
-15.2
-10.0
-5.4
-4.59

-35.5
-32.0
-29.2
-26.4
-24.4
-17.0
-10.3
-8.9

-57.1
-51.5
-47.0
-42.1
-39.1
-27.8
-17.6
-15.5

1%
2.5%
5%
10%
15%
50%
90%
95%

-6.1
-5.4
-4.75
-4.09
-3.64
-1.9
.2
.79

-12.2
-10.9
-9.7
-8.6
-7.8
-4.62
-1.77
-1.26

-19.7
-17.8
-16.2
-14.4
-13.3
-8.9
-4.83
-4.06

-29.1
-26.5
-24.5
-22.1
-20.6
-14.5
-8.9
-7.8

-42.5
-39.1
-36.1
-32.8
-30.7
-22.3
-14.5
-12.8

-65.5
-59.7
-54.9
-49.7
-46.3
-34.0
-22.8
-20.3

If the qy or qHtestsare
k; thequantilesforreal()Nj)andreal(Aj) aregiveninTa- -8.5 and -11.5, respectively.
bles2 and3, respectively.
Referring
toTable 1,theblocks used,thecriticalvaluescomefromTable 2. If theq or
of rowsrepresent
thedimension
of A,or equivalently
k, qctestsare used,thecriticalvaluescomefromTable 3.
oftheqj(k, k - 1) and
nulldistribution
The asymptotic
thedimension
of W,used to construct
theqf or q, tests.
of the real
the
distribution
Thecolumns
ofthetabledenotethejth-largest
eigenvalue, ql(k, k - 1) statistics
[i.e:,
to theeigenvalue
corresponding
on whichthetestis based partofthesmallesteigenvalueofPS'(FM)1] is plottedin
whentherearem = j - 1 unitrootsunderthealternative. Figure 1 fork = 1, . . , 6. The figureemphasizeshow
For example,in a testofk = 4 versusm = 3 unitroots, severelythecdf'sof thesmallesteigenvaluesare shifted
theqf(4,3) orq,(4, 3) testswouldbe basedon thefourth- below0, evenwhenk = 1 or 2.
largesteigenvalue,so the 5% criticalvalue forthe test
7. SIZEAND POWERCOMPUTATIONS
(takenfromTable 1) is -34.4 and the1% criticalvalue
is -43.3. For a testof k = 4 versusm = 1 unitroots,
Thissectionreportstheresultsofa smallMonteCarlo
on
test
would
be
based
the
thesizeandpowerofthetests
the qf(4, 1)
second-largestexperiment
thatinvestigates
in appliedwork.
for
sizes
encountered
typically
eigenvalue, whichthe5% and 1% criticalvaluesare insamplesof
.

1105

Stock and Watson: Testing forCommon Trends

Table 3. Quantiles of real(*)
Dimension
of AT

Significance
level

Eigenvalue number
1

1%
2.5%
5%
10%
15%
50%
90%
95%

-29.2
-24.8
-21.7
-18.2
-16.1
-9.0
-3.8
-2.7

1%
2.5%
5%
10%
15%
50%
90%
95%

-19.1
-16.8
-14.9
-12.9
-11.6
-7.0
-2.94
-1.97

-39.2
-34.6
-30.8
-26.7
-24.2
-15.1
-7.6
-6.3

1%
2.5%
5%
10%
15%
50%
90%
95%

-15.2
-13.4
-12.1
-10.7
-9.7
-6.2
-2.52
-1.55

-27.1
-24.3
-22.1
-19.5
-17.8
-11.3
-5.9
-4.91

-48.7
-43.5
-39.0
-34.6
-31.8
-21.4
-12.5
-10.7

1%
2.5%
5%
10%
15%
50%
90%
95%

-13.2
-11.8
-10.7
-9.5
-8.7
-5.7
-2.23
-1.32

-22.0
-19.8
-18.0
-16.0
-14.7
-9.5
-5.1
-4.19

-35.3
-31.6
-28.9
-25.9
-24.0
-16.7
-10.0
-8.7

-57.2
-51.7
-47.0
-42.0
-38.9
-27.6
-17.4
-15.3

1%
2.5%
5%
10%
15%
50%
90%
95%

-12.2
-10.9
-9.8
-8.7
-8.0
-5.3
-2.12
-1.20

-19.0
-17.2
-15.7
-14.0
-12.8
-8.4
-4.50
-3.72

-28.7
-26.3
-24.2
-21.9
-20.4
-14.3
-8.8
-7.7

-42.4
-38.8
-35.9
-32.6
-30.4
-22.1
-14.2
-12.6

-64.6
-59.2
-54.5
-49.2
-46.0
-33.7
-22.5
-20.1

1%
2.5%
5%
10%
15%
50%
90%
95%

-11.2
-10.1
-9.1
-8.1
-7.5
-4.99
-2.00
-1.06

-17.0
-15.4
-14.1
-12.6
-11.6
-7.5
-4.05
-3.36

-25.1
-23.1
-21.3
-19.3
-18.0
-12.9
-8.0
-7.0

-35.3
-32.7
-30.2
-27.7
-26.0
-19.1
-12.5
-11.0

-49.7
-45.7
-42.5
-38.9
-36.7
-27.6
-18.8
-16.9

-73.2
-67.1
-62.4
-56.8
-53.2
-39.9
-27.8
-25.2

p = 1, so therearetwo
The qj(2, 1) and q"(2, 1) testswerestudiedusingtwo value.Underthenullhypothesis,
II < 1, andthere
by commontrends;underthealternative,
modelsforY,. In thefirst,Y, was generated
different
is onlyone commontrend.The testswerecomputedas
theVAR(2)
describedin the previoussections,usingprincipalcom(7.1) ponentsto construct
L) (1 - <>L)Yt = c"
(1
D fromthegeneratedY,. Although
(since
by(7.1) or (7.2) is notcointegrated
(autoregressiveY,as generated
and in the secondby the mixed-vector
movingaverage)ARMA (1, 1) process
Y3,is not integrated),because D is computedby principal
wouldbe
teststatistics
equivalent
numerically
components
(7.2) obtainedusingX, = PYt, whereP is any nonsingular
(1 - .FL) Yt = (1 + OL)et,
P couldbe chosenso thatX,is coinIn particular,
matrix.
wherein (7.1) and (7.2) Ecte' = G, and where
tegrated.
1 .5 - .25
1 0 O
using2,000replicawereperformed
The experiments
.5a
.5
1
are
s
G
Bt = a
p
tionswitha samplesizeof T = 200.Thissampleis typical
1
- .25 .5
O O .5
research;forexample,
of thatfoundin macroeconomic
NationalIncomeand ProductAcBoth and 0 are scalarsthatare less than1 in absolute thepostwarquarterly
A

Journalof the American StatisticalAssociation,December 1988

1106

containresultsforthevectorARMA model(7.2) with0

= .4. The nominal
sizesoftheql test(columnsA andC)
abovetheiractuallevel,whereasthenomare somewhat
inalsize oftheqI testis aboveitslevelwhenthedataare
belowits
bya VAR (columnB) andsomewhat
generated
bya vectorMA (column
levelwhenthedataaregenerated
greaternominal
D). In addition,theqy(2,1) testexhibits
q#(2,1) testwiththeVAR
powerthantheapproximate
process,whereasthereverseis truewhen
data-generation
thedata are generatedbythevectorARMA process.

k=6

.8

>.6
-0

.2

-80

-70

-60

-50

-40

-30

-20

-10

10

U.S.
8. COMMON TRENDSIN POSTWAR
RATES
INTEREST

Re (kg)

ofcommontrends
In thissectionwe testforthenumber
maturities.
rateswithdifferent
amongthreeU.S. interest
1960
fromJanuary
observations
The dataare236monthly
countsdatasetfrom1947:1to 1986:4contains160obser- toAugust1979onthefederal
fundsrate(FF) (an overnight
financial
data set e ;aminedin interbank
vations,and the monthly
billrate(TB3),
loan rate),the90-daytreasury
Section8 has 236 observations.
Initialvaluesof Y0 = co and theone-yeartreasury
billrate(TB12). The treasury
= 0 wereused, and the testswerecomputedusingthe billratesare secondary
marketrates,and all ratesare on
generateddata Y1, . . . , Y200.Fewer observationswere an annualizedbasis. All threerateswereobtainedfrom
en- theCitibasefinancial
used to computetheVAR's and covariancematrices
data base.
teringthecorrection
termsas necessary.
The q1(2, 1) test
of interest
ratessugThe theoryof thetermstructure
windowof geststhatthereis at mostone commonstochastic
statistics
werecomputedusinga rectangular
trend
orderJ, so K(j) = 1 for11is J and 0 otherwise.
When underlying
thesethreerates:Becausetheexpectedreturn
thedataweregenerated
by(7.1), theq (2, 1) statistic
was on a multiperiod
intheory
instrument
equalstheexpected
oftheintegrated return
computed
byfiltering
thefirst
differences
overa sequenceofone-period
obtainedfromrolling
(underthenull)components
usingan estimated
VAR(1); instruments,
rateis
a stochastic
trendin the short-term
thecorrection
termM intheq1(2,1) statistic
wasestimated inherited
rate.
bythelonger-term
usinga windowof orderJ = 3. Whenthe data were
Table 5 presentsvarioustestsforunitrootsin these
wasestimated
generated
by(7.2), theqJ(2,1) filter
using interest
rates.Althoughall threeratesappearto contain
a VAR(3); theq1(2, 1) correction
was estimated
usingJ a unitroot,thedifferences
amongthem(thespreads)seem
= 1. Thustheorderof thefilter
in theqJ(2,1) statistic to be stationary.
of theDickey-Fuller
T (4)
[Application
was correctunderthenullwhenthedataweregenerated testto thefirstdifference
raterejectsthe
ofeachinterest
by (7.1), and the orderof the windowin the q1(2, 1) nullof a secondunitrootat the1% level.]Thissuggests
statistic
was correctunderthe nullwhenthe data were thatthereis a singlecommontrend.The multivariate
regeneratedby(7.2). In theothercases,a longerVAR (or sultsconfirm
for3 versus1 common
Testing
thissuspicion.
to approxadditionalcovarianceterms)was incorporated
the
MA
vector
imatethecovariancestructure
impliedby
Monthly
Testson Three
andCointegration
Table5. Integration
Interest
Rates,1960:1-1979:8
in
under
the
null.
first
differences
(or AR)
ColumnsA and B of Table 4 containresultsforthe
Univariate
results
VAR model (7.1) withq = 4, and columnsC and D
ofreal(A,k).
Distribution
Function
Figure1. Cumulative

Table4. MonteCarloExperiment
Results:RejectionProbabilities
Data-generating
process
(7.1), with0

A,

.4

B,

(7.2), with0 = .4

C,

D,

Level

qv(2, 1)

1)
q,0'(2,

q (2, 1)

q,(2, 1)

1.00

5%
10%
5%
10%
5%

.03
.07

.03
.06

.03
.06

.11
.21
.40

.10
.18
.34

.08
.19
.30

.07
.13
.22
.35
.60

5%
10%

.92
.97

.82
.90

.86
.95

.99
.99

.95
.90
.80

10%

.59

.50

.51

.74

NOTE: The results

werecomputed
using2,000MonteCarlodrawswitha samplesize ofT
= 200.

Sampleautocorrelations

Series

Lag 1

Lag2

FF
.941
.975
.936
TB3
.971
.935
TB12
.972
.825
FF-TB3
.902
.863
FF-TB12
.932
.727
TB3-TB12
.851
Common
trend
tests
qy(3,1);p = 2, -22.6a;p = 4, -21.6a
qy(2,1);p = 2, - 23.2b;p = 4, -23.5b
1);J = 2, -24.7b;J = 4, -296b
q#(2,

Lag3
.899
.899
.898
.741
.801
.614

T(4)

-1.79
-1.44
-1.34
- 3.17b
- 2.82c
- 4.09a

NOTE: i(4) denotesthe Dickey-Fuller

series
(1979) t testfora unitrootin a univariate
using
werecomputed
an estimated
Theq#statistics
constant
with
anAR(4)correction.
including
FF denotesthefederal
autocovariances.
theJestimated
a flatkemelforK(j) in(4.1) toweight
treasury
billrate,andTB12denotestheone-year
fundsrate,TB3denotesthe90-daytreasury
billrate.
a Significant
at the1% level.
b Significant
at the5% level.
Significant
level.
atthe10%h

Stock and Watson: Testing forCommon Trends

trendusingthe qy(3, 1) statistic,

fromTable 2 the 5%
valueis -20.1.
critical
valueis - 15.7andthe1% critical
are morenegativethanboth
The reportedteststatistics
atthe1% level.
ofthesecritical
values,indicating
rejection
Testsof the morerefinedhypothesis
of 2 versus1 also
rejectthenullin favorof a modelin whichthesethree
ratescontaina singlecommontrend.

1107

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cointegrated
seasonalmodels.In particular,
supposethat
NorthCarolina State University,Dept. of Statistics.
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0;
M. W. (1987), "Stohowever,it is possiblethatalternative
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