VAR Models and Cointegration

VAR Models and Cointegration
Sebastian Fossati
University of Alberta
1 These
slides are based on Eric Zivots time series notes available at:
http://faculty.washington.edu/ezivot
The Cointegrated VAR
In a series of important papers Soren Johansen firmly roots cointegration and

error correction models in a vector autoregression framework.
Consider the levels VAR(p) for the (n 1) vector Y t

Yt
Dt
D t + 1 Y t1 + + p Y tp + t ,
t = 1, . . . , T
deterministic terms
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The VAR(p) model is stable if

det(I n 1 z p z p ) = 0
has all roots outside the complex unit circle.
If there are roots on the unit circle then some or all of the variables in
Y t are I (1) and they may also be cointegrated.
If Yt is cointegrated then the VAR representation is not the most

suitable representation for analysis because the cointegrating relations
are not explicitly apparent.
3 / 64
The cointegrating relations become apparent if the levels VAR is

transformed to the vector error correction model (VECM)
Y t
= D t + Y t1 + 1 Y t1 + . . . + p1 Y tp+1 + t
= 1 + . . . + p I n
p
X
=
j , k = 1, . . . , p 1
j=k+1
In the VECM, Y t and its lags are I (0).
The term Y t1 is the only one which includes potential I (1) variables
and for Y t to be I (0) it must be the case that Y t1 is also I (0).
Therefore, Y t1 must contain the cointegrating relations if they exist.
If the VAR(p) process has unit roots (z = 1) then

det(I n 1 . . . p ) = 0
det() = 0
is singular
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If is singular then it has reduced rank; that is rank() = r < n. There are
two cases to consider:
1. rank() = 0. This implies that
=0
Y t I (1) and not cointegrated
The VECM reduces to a VAR(p 1) in first differences
Y t = D t +1 Y t1 + . . . + p1 Y tp+1 + t
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2. 0 < rank() = r < n. This implies that Y t is I (1) with r linearly

independent cointegrating vectors and n r common stochastic trends
(unit roots). Since has rank r it can be written as the product
=
(nn)
(nr )(r n)
where and are (n r ) matrices with rank() = rank() = r . The

rows of 0 form a basis for the r cointegrating vectors and the elements
of distribute the impact of the cointegrating vectors to the evolution
of Y t . The VECM becomes
Y t = D t + 0 Y t1 + 1 Y t1 + . . . + p1 Y tp+1 + t ,
where 0 Y t1 I (0) since 0 is a matrix of cointegrating vectors.
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Non-uniqueness
It is important to recognize that the factorization = 0 is not unique

since for any r r nonsingular matrix H we have
0 = HH 1 0 = (aH)(H
10
) = a 0
Hence the factorization = 0 only identifies the space spanned by the

cointegrating relations. To obtain unique values of and 0 requires further
restrictions on the model.
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Example: A bivariate cointegrated VAR(1) model

Consider the bivariate VAR(1) model for Y t = (y1t , y2t )0
Y t = 1 Y t1 + t
The VECM is
Y t = Y t1 + t
= 1 I 2
Assuming Y t is cointegrated there exists a 2 1 vector = (1 , 2 )0 such
that
0 Y t = 1 y1t + 2 y2t I (0)
Using the normalization 1 = 1 and 2 = the cointegrating relation
becomes
0 Y t = y1t y2t
This normalization suggests the stochastic long-run equilibrium relation
y1t = y2t + ut
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Since Y t is cointegrated with one cointegrating vector, rank() = 1 so that

!
!

1
1 1
0
= =
1 =
2
2 2
The elements in the vector are interpreted as speed of adjustment
coefficients. The cointegrated VECM for Y t may be rewritten as
Y t = 0 Y t1 + t
Writing the VECM equation by equation gives
y1t
= 1 (y1t1 y2t1 ) + 1t
y2t
= 2 (y1t1 y2t1 ) + 2t
The stability conditions for the bivariate VECM are related to the stability
conditions for the disequilibrium error 0 Y t .
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It is straightforward to show that 0 Y t follows an AR(1) process

0
0 Y t = (1 + 0 ) Y t1 + 0 t
or
ut
= ut1 + vt , ut = 0 Y t
= 1 + 0 = 1 + (1 2 )
vt
= 0 t = u1t u2t
The AR(1) model for ut is stable as long as

|| = |1 + (1 2 )| < 1
For example, suppose = 1. Then the stability condition is
|| = |1 + (1 2 )| < 1
which is satisfied if
1 2 < 0 and 1 2 > 2.
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Johansens Methodology for Modeling Cointegration
The basic steps in Johansens methodology are:

I
Specify and estimate a VAR(p) model for Y t .
Construct likelihood ratio tests for the rank of to determine the

number of cointegrating vectors.
If necessary, impose normalization and identifying restrictions on the

cointegrating vectors.
Given the normalized cointegrating vectors estimate the resulting

cointegrated VECM by maximum likelihood.
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LR Tests for the Number of Cointegrating Vectors
The unrestricted cointegrated VECM is denoted H(r ). The I (1) model H(r )
can be formulated as the condition that the rank of is less than or equal to
r . This creates a nested set of models
H(0)
H(r ) H(n)
H(0)
= non-cointegrated VAR
H(n)
stationary VAR(p)
This nested formulation is convenient for developing a sequential procedure

to test for the number r of cointegrating relationships.
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Remarks:
I
Since the rank of the long-run impact matrix gives the number of
cointegrating relationships in Y t , Johansen formulates likelihood ratio
(LR) statistics for the number of cointegrating relationships as LR
statistics for determining the rank of .
These LR tests are based on the estimated eigenvalues

1 >
2 > >
n of the matrix . These eigenvalues also happen to
equal the squared canonical correlations between Y t and Y t1

corrected for lagged Y t and D t and so lie between 0 and 1. Recall,
the rank of is equal to the number of non-zero eigenvalues of .
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Johansens Trace Statistic

Johansens LR statistic tests the nested hypotheses
H0 (r ) : r = r0 vs. H1 (r0 ) : r > r0
The LR statistic, called the trace statistic, is given by
LRtrace (r0 ) = T
n
X
i )
ln(1
i=r0 +1
r +1 , . . . ,
n should all be close to zero and
If rank() = r0 then
0
i ) 0 for i > r0 .
LRtrace (r0 ) should be small since ln(1
r +1 , . . . ,
n will be nonzero
In contrast, if rank() > r0 then some of
0
i ) << 0
(but less than 1) and LRtrace (r0 ) should be large since ln(1
for some i > r0 .
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The asymptotic null distribution of LRtrace (r0 ) is not chi-square but

instead is a multivariate version of the Dickey-Fuller unit root
distribution which depends on the dimension n r0 and the specification
of the deterministic terms. Critical values for this distribution are
tabulated in Osterwald-Lenum (1992) for n r0 = 1, . . . , 10.
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Determining the Number of Cointegrating Vectors

A sequential procedure is used to determine the number of cointegrating
vectors:
1. First test H0 (r0 = 0) against H1 (r0 > 0). If this null is not rejected then
it is concluded that there are no cointegrating vectors among the n
variables in Y t .
2. If H0 (r0 = 0) is rejected then it is concluded that there is at least one
cointegrating vector and proceed to test H0 (r0 = 1) against H1 (r0 > 1).
If this null is not rejected then it is concluded that there is only one
cointegrating vector.
3. If the H0 (r0 = 1) is rejected then it is concluded that there is at least
two cointegrating vectors.
4. The sequential procedure is continued until the null is not rejected.
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Johansens Maximum Eigenvalue Statistic

Johansen also derives a LR statistic for the hypotheses
H0 (r0 ) : r = r0 vs. H1 (r0 ) : r0 = r0 + 1
The LR statistic, called the maximum eigenvalue statistic, is given by
r0 +1 )
LRmax (r0 ) = T ln(1
As with the trace statistic, the asymptotic null distribution of LRmax (r0 ) is
not chi-square but instead is a complicated function of Brownian motion,
which depends on the dimension n r0 and the specification of the
deterministic terms. Critical values for this distribution are tabulated in
Osterwald-Lenum (1992) for n r0 = 1, . . . , 10.
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Specification of Deterministic Terms
Following Johansen (1995), the deterministic terms in are restricted to the

form
D t = t = 0 + 1 t
If the deterministic terms are unrestricted then the time series in Y t may
exhibit quadratic trends and there may be a linear trend term in the
cointegrating relationships. Restricted versions of the trend parameters 0
and 1 limit the trending nature of the series in Y t . The trend behavior of
Y t can be classified into five cases:
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1. Model H2 (r ): t = 0 (no constant):

Y t = 0 Y t1 + 1 Y t1 + . . . + p1 Y tp+1 + t
and all the series in Y t are I (1) without drift and the cointegrating
relations 0 Y t have mean zero.
2. Model H1 (r ): t = 0 = 0 (restricted constant):
0
Y t = ( Y t1 + 0 ) + 1 Y t1 + . . . + p1 Y tp+1 + t
the series in Y t are I (1) without drift and the cointegrating relations
0 Y t have non-zero means 0 .
3. Model H1 (r ): t = 0 (unrestricted constant):
Y t = 0 + 0 Y t1 + 1 Y t1 + . . . + p1 Y tp+1 + t
the series in Y t are I (1) with drift vector 0 and the cointegrating
relations 0 Y t may have a non-zero mean.
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4. Model H (r ): t = 0 + 1 t (restricted trend). The restricted VECM

is
Y t
= 0 + ( Y t1 + 1 t)
+ 1 Y t1 + . . . + p1 Y tp+1 + t
the series in Y t are I (1) with drift vector 0 and the cointegrating
relations 0 Y t have a linear trend term 1 t.
5. Model H(r ): t = 0 + 1 t (unrestricted constant and trend). The
unrestricted VECM is
Y t
= 0 + 1 t + 0 Y t1
+ 1 Y t1 + . . . + p1 Y tp+1 + t
the series in Y t are I (1) with a linear trend (quadratic trend in levels)
and the cointegrating relations 0 Y t have a linear trend.
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Simulated Y t from Bivariate Cointegrated VECM

Case 2: Restricted constant
10
Case 1: No constant
50
100
150
200
50
100
150
Time
Time
Case 3: Unrestricted constant
Case 4: Restricted trend
200
40
40
80
80
120
120
50
100
150
200
Time
50
100
150
200
Time
500
2000
Case 5: Unrestricted trend
50
100
Time
150
200
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Simulated 0 Y t from Bivariate Cointegrated VECM

Case 2: Restricted constant
9
5
11
Case 1: No constant
50
100
150
200
50
100
150
Time
Time
Case 3: Unrestricted constant
Case 4: Restricted trend
200
10
20
30
10
50
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150
200
Time
50
100
150
200
Time
15
Case 5: Unrestricted trend
50
100
Time
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200
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Johansens Cointegration Tests in R

The package urca includes functions for cointegration analysis based on
Johansens methods.
> ca.jo
function (x, type = c("eigen", "trace"), ecdet = c("none", "const",
"trend"), K = 2, spec = c("longrun", "transitory"),...)
Note:
I
This function considers 3 specifications for the deterministic term:

I
I
I
none corresponds to case 1, i.e. no constant

const corresponds to case 2, i.e. restricted constant
trend corresponds to case 4, i.e. restricted trend
K is the number of lags for the VAR in levels, so K 1 is the number of

lags in the VECM representation
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Example 1: Testing for Cointegration

Simulated data set 1:
>
>
>
>
>
>
>
ut = 0.75ut1 + 1t
y1t
y2t + ut ,
y2t
y2t1 + 2t
it
iid N(0, (0.5)2 ) for i = 1, 2
# Example (1) bivariate cointegrated system

nobs <- 250
e <- rmvnorm(n=nobs,sigma=diag(c(.5,.5)))
u.ar1 <- arima.sim(model=list(ar=.75),nobs,innov=e[,1])
y2 <- cumsum(e[,2])
y1 <- y2 + u.ar1
data1 <- cbind(y1,y2)
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Example 1: Trace Statistic

> # trace statistic
> test1 <- ca.jo(data1,ecdet="const",type="trace",K=2,spec="transitory")
> summary(test1)
Test type: trace statistic , without linear trend and constant in cointeg
Eigenvalues (lambda):
[1] 8.231476e-02 1.776963e-02 -2.951772e-20
Values of teststatistic and critical values of test:
test 10pct 5pct 1pct
r <= 1 | 4.45 7.52 9.24 12.97
r = 0 | 25.75 17.85 19.96 24.60
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Test finds 1 cointegrating vector

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Example 1: Max Eigenvalue Statistic

> # max eigenvalue statistic
> test2 <- ca.jo(data1,ecdet="const",type="eigen",K=2,spec="transitory")
> summary(test2)
Test type: maximal eigenvalue statistic (lambda max) , without linear tre
[1] 8.231476e-02 1.776963e-02 -2.951772e-20
r <= 1 | 4.45 7.52 9.24 12.97
r = 0 | 21.30 13.75 15.67 20.20
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>
>
>
>
>
>
>
>
yt1
0.5y2t + 0.5y3t + ut ,
ut = 0.75ut1 + 1t
y2t
y2t1 + 2t
y3t
y3t1 + 3t
it
iid N(0, (0.5)2 ) for i = 1, 2, 3
# Example (2) trivariate cointegrated system (1 coint vector)

nobs <- 250
e <- rmvnorm(n=nobs,sigma=diag(c(.5,.5,.5)))
y2 <- cumsum(e[,2])
y3 <- cumsum(e[,3])
y1 <- .5*y2 + .5*y3 + u.ar1
data2 <- cbind(y1,y2,y3)
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> # trace statistic
> summary(test1)
[1] 1.473355e-01 1.784372e-02 1.016651e-02 3.564194e-18
r <= 2 | 2.53 7.52 9.24 12.97
r <= 1 | 7.00 17.85 19.96 24.60
r = 0 | 46.53 32.00 34.91 41.07
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>
>
>
>
>
>
>
>
>
y1t
y3t + ut ,
ut = 0.75ut1 + 1t
y2t
y3t + vt ,
vt = 0.75vt1 + 2t
y3t
y3t1 + 3t
it
iid N(0, (0.5)2 ) for i = 1, 2, 3
# Example (3) trivariate cointegrated system (2 coint vectors)

nobs <- 250
e <- rmvnorm(n=nobs,sigma=diag(c(.5,.5,.5)))
v.ar1 <- arima.sim(model=list(ar=.75),nobs,innov=e[,2])
y3 <- cumsum(e[,3])
y1 <- y3 + u.ar1
y2 <- y3 + v.ar1
data3 <- cbind(y1,y2,y3)
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> # trace statistic
> summary(test1)
[1] 1.271274e-01 8.669117e-02
1.631739e-02 -3.400303e-18

r <= 2 | 4.08 7.52 9.24 12.97
r <= 1 | 26.57 17.85 19.96 24.60
r = 0 | 60.29 32.00 34.91 41.07
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Test finds 2 cointegrating vectors

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Maximum Likelihood Estimation of the VECM

If it is found that rank() = r , 0 < r < n, then the cointegrated VECM
Y t = D t + 0 Y t1 + 1 Y t1 + . . . + p1 Y tp+1 + t
becomes a reduced rank multivariate regression. Johansen derived the
maximum likelihood estimation of the parametes under the reduced rank
restriction rank() = r (see Hamilton for details). He shows that
I
mle = (
v 1 , . . . , vr ), where vi are the eigenvectors associated with the
i
eigenvalues
The MLEs of the remaining parameters are obtained by least squares

estimation of
0
Y t = D t + mle Y t1 + 1 Y t1 + . . . + p1 Y tp+1 + t
31 / 64
Normalized Estimates of and
The factorization
0
mle =
mle mle
is not unique.
I
The columns of mle may be interpreted as linear combinations of the

underlying cointegrating relations.
For interpretations, it is often convenient to normalize or identify the

cointegrating vectors by choosing a specific coordinate system in which
to express the variables.
32 / 64
Johansens normalized MLE

I
An arbitrary normalization, suggested by Johansen, is to solve for the

triangular representation of the cointegrated system. The resulting
normalized cointegrating vector is denoted c,mle . The normalization of
the MLE for to c,mle will affect the MLE of but not the MLEs of
the other parameters in the VECM.
Let c,mle denote the MLE of the normalized cointegrating matrix c .

Johansen (1995) showed that
T (vec(c,mle ) vec( c ))
is asymptotically (mixed) normally distributed.
c,mle is super consistent.
33 / 64
Testing Linear Restrictions on

The Johansen MLE procedure only produces an estimate of the basis for the
space of cointegrating vectors. It is often of interest to test if some
hypothesized cointegrating vector lies in the space spanned by the estimated
basis:
!
00
0
H0 :
=
0
(r n)
00
s n matrix of hypothesized cvs

(r s) n matrix of remaining unspecified cvs
Result: Johansen (1995) showed that a likelihood ratio statistic can be

computed, which is asymptotically distributed as a 2 with s(n r ) degrees
of freedom.
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Example 1 continued...
The test statistics found 1 cointegrating vector, i.e. r = 1. The function
cajorls (urca package) estimates the restricted VECM.
> # estimate restricted VECM
> model1 <- cajorls(test1,r=1)
> print(model1)
$rlm
$beta
ect1
y1.l1
1.0000000
y2.l1
-1.0034079
constant -0.1291761
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Note that the coefficients closely match those in the DGP
35 / 64
Restricted VECM
Response y1.d :
Coefficients:
Estimate Std. Error t value Pr(>|t|)
ect1
-0.21032
0.05790 -3.632 0.000342 ***
y1.dl1 -0.13811
0.08981 -1.538 0.125395
y2.dl1 0.17801
0.12538
1.420 0.156953
Residual standard error: 0.9916 on 245 degrees of freedom
Multiple R-squared: 0.08232, Adjusted R-squared: 0.07108
F-statistic: 7.326 on 3 and 245 DF, p-value: 0.0001008
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Note that y1t depends on the cointegrating vector
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Restricted VECM
Response y2.d :
Coefficients:
ect1
-0.01956
0.04247 -0.461
0.645
y1.dl1 -0.06557
0.06588 -0.995
0.321
y2.dl1 0.06573
0.09197
0.715
0.475
Multiple R-squared: 0.006811, Adjusted R-squared: -0.005351
I
Note that y2t does not depend on the cointegrating vector
37 / 64
Testing Restrictions on
Hypotheses on the long-run coefficients can be formulated in terms of

linear restrictions on :
H0 : R 0 = 0
or
= B
where are the unknown parameters in the cointegrating vectors ,

B = R and R is the orthogonal complement of R such that R 0 R = 0.
38 / 64
Suppose we want to test whether the cointegrating vector is 0 = (1, 1)
without imposing any restrictions on the intercept.
With the notation = ( 0 , 3 )0 = (1 , 2 , 3 )0 the hypothesis becomes
1 = 2 . Note that the vector is typically normalized such that 1 = 1.
In terms of the parameterization = B, the matrix B is given by
1 0
B = 1 0
0 1
and = (1 , 2 )0 such that B = (1 , 1 , 2 )0 .
In terms of the parameterization R 0 = 0, the matrix R 0 is given by
R 0 = (1, 1, 0) which implies 1 + 2 = 0 and 3 unrestricted. Note that
R 0 B = 0.
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> B1 <- matrix(c(1,-1,0,0,0,1),nrow=3)
> B1
[,1] [,2]
[1,]
1
0
[2,]
-1
0
[3,]
0
1
> R <- Null(B1)
> R
[,1]
[1,] -0.7071068
[2,] -0.7071068
[3,] 0.0000000
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The test can be performed by passing the matrix B to the test function
40 / 64
> # test restrictions on beta
> test3 <- blrtest(z=test1,H=B1,r=1)
> summary(test3)
Estimation and testing under linear restrictions on beta
Eigenvalues of restricted VAR (lambda):
[1] 0.0823 0.0022
The value of the likelihood ratio test statistic:
0 distributed as chi square with 1 df.
The p-value of the test statistic is: 0.96
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The restrictions are not rejected
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Estimate VECM with Restrictions on

> # estimate VECM with beta restrictions
> print(model2)
$rlm
$beta
ect1
y1.l1
1.0000000
y2.l1
-1.0000000
constant -0.1040501
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The estimated cointegrating vector now satisfies the imposed restriction:

1 + 2 = 0 while the intercept remains unrestricted
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Suppose we want to test whether the cointegrating vector is 0 = (1, 1)
with no intercept, i.e we want R 0 = 0 such that 1 + 2 = 0 and 3 = 0.
> B2 <- matrix(c(1,-1,0),nrow=3)
> B2
[,1]
[1,]
1
[2,]
-1
[3,]
0
> R <- Null(B2)
> R
[,1] [,2]
[1,] 0.7071068
0
[2,] 0.7071068
0
[3,] 0.0000000
1
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> summary(test4)
[1] 0.0816
0.2 distributed as chi square with 2 df.
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> print(model3)
$rlm
$beta
y1.l1
y2.l1
constant
I
ect1
1
-1
0
The estimated cointegrating vector now satisfies the imposed

restrictions: 1 + 2 = 0 and 3 = 0
45 / 64
Suppose we want to test whether 2 = 0 without imposing any restrictions
on 1 , i.e. we want to test for weak exogeneity of y2t . This hypothesis can
be represented as a linear restriction on :
H0 : R 0 = 0
or
= A
The matrix R is given by R = (0, 1)0 which implies 2 = 0 and 1

unrestricted.
> A1 <- matrix(c(1,0),nrow=2)
> R <- Null(A1)
> R
[,1]
[1,]
0
[2,]
1
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The test can be performed by passing the matrix A to the test function
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> # test weak exogeneity
> test5 <- alrtest(z=test1,A=A1,r=1)
> summary(test5)
Weights W of the restricted VAR:
[,1]
[1,] -0.1917
[2,] 0.0000
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Testing Restrictions on and

We can test the restrictions on and jointly.
> # test restriction on beta and weak exogeneity
> test6 <- ablrtest(z=test1,A=A1,H=B2,r=1)
> summary(test6)
Estimation and testing under linear restrictions on alpha and beta
[1] 0.0804
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48 / 64

Eigenvectors, normalised to first column
of the restricted VAR:
[,1]
[1,]
1
[2,]
-1
[3,]
0
[,1]
[1,] -0.1891
[2,] 0.0000
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The estimated vectors now satisfy the imposed restrictions: 1 + 2 = 0,

3 = 0, and 2 = 0
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Example 3 continued...
The test statistics found 2 cointegrating vectors, i.e. r = 2. The function
> # estimate restricted VECM
> print(model1)
$rlm
$beta
ect1
ect2
y1.l1
1.000000e+00 0.0000000
y2.l1
-2.775558e-17 1.0000000
y3.l1
-9.585393e-01 -1.0742611
constant 4.111800e-01 -0.4397609
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Note that the coefficients closely match those in the DGP

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Restricted VECM
Response y1.d :
Coefficients:
ect1
-0.285491
0.064924 -4.397 1.64e-05 ***
ect2
0.042028
0.059752
0.703
0.482
y1.dl1 -0.003464
0.091613 -0.038
0.970
y2.dl1 -0.061869
0.092450 -0.669
0.504
y3.dl1 -0.043577
0.153542 -0.284
0.777
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Note that y1t only depends on the first cointegrating vector

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Restricted VECM
Response y2.d :
Coefficients:
ect1
-0.023165
0.065564 -0.353
0.7242
ect2
-0.142426
0.060340 -2.360
0.0190 *
y1.dl1 -0.206148
0.092516 -2.228
0.0268 *
y2.dl1 -0.005361
0.093361 -0.057
0.9543
y3.dl1 0.105134
0.155054
0.678
0.4984
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Note that y2t only depends on the second cointegrating vector

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Restricted VECM
Response y3.d :
Coefficients:
ect1
-0.02320
0.04787 -0.485
0.628
ect2
0.05180
0.04405
1.176
0.241
y1.dl1 -0.07472
0.06754 -1.106
0.270
y2.dl1 0.04176
0.06816
0.613
0.541
y3.dl1 -0.07061
0.11320 -0.624
0.533
I
Note that y3t does not depend on any of the cointegrating vectors
53 / 64
Suppose we want to test 11 + 13 = 0 and 22 + 23 = 0 without imposing
any restrictions on the intercept.
In terms of the parameterization R 0 = 0, the matrix R 0 is given by
R 0 = (1, 1, 1, 0) which implies 11 + 13 = 0 and 22 + 23 = 0, with 14 and
24 unrestricted. Note that the matrix is typically normalized such that
11 = 22 = 1 and 12 = 21 = 0.
> B1 <- matrix(c(1,0,-1,0,0,1,-1,0,0,0,0,1),nrow=4)
> R <- Null(B1)
> R
[,1]
[1,] -0.5773503
[2,] -0.5773503
[3,] -0.5773503
[4,] 0.0000000
54 / 64
> summary(test3)
[1] 0.1248 0.0850 0.0012
I
55 / 64

> print(model2)
$rlm
$beta
ect1
ect2
y1.l1
1.000000 0.0000000
y2.l1
0.000000 1.0000000
y3.l1
-1.000000 -1.0000000
constant 0.261947 -0.1691561
I
The estimated cointegrating vectors now satisfy the imposed restrictions:

11 + 13 = 0 and 22 + 23 = 0 while the intercepts remain unrestricted
56 / 64
>
>
>
>
# test weak exogeneity of y3t

A1 <- matrix(c(1,0,0,0,1,0),nrow=3)
test4 <- alrtest(z=test1,A=A1,r=2)
summary(test4)

[,1]
[,2]
[1,] -0.2514 -0.0116
[2,] 0.0518 -0.0514
[3,] 0.0000 0.0000
I

57 / 64

We can test the restrictions on and jointly.
> # test restriction on beta and weak exogeneity
> test5 <- ablrtest(z=test1,A=A1,H=B1,r=2)
> summary(test5)
Estimation and testing under linear restrictions on alpha and beta
[1] 0.1239 0.0829 0.0000
I

58 / 64
Zivot (2000) continued...

>
>
>
>
# trace test
data <- cbind(st,ft)
test1 <- ca.jo(data,ecdet="const",type="trace",K=2,spec="transitory")
summary(test1)
[1] 5.922276e-02 2.205465e-02 -6.938894e-18
r <= 1 | 5.42 7.52 9.24 12.97
r = 0 | 20.25 17.85 19.96 24.60
I
The test finds 1 cointegrating vector

59 / 64
Estimate Restricted VECM

The test statistics found 1 cointegrating vectors, i.e. r = 1. The function
> # estimate restricted model
> print(model1)
$rlm
$beta
ect1
st.l1
1.000000000
ft.l1
-1.000860977
constant -0.001915953
60 / 64
Restricted VECM
Response st.d :
Coefficients:
ect1
1.65502
0.82642
2.003
0.0463 *
st.dl1 0.03872
1.89308
0.020
0.9837
ft.dl1 0.03062
1.89125
0.016
0.9871
I
Note that st only depends on the cointegrating vector
61 / 64
Restricted VECM
Response ft.d :
Coefficients:
ect1
1.745423
0.825300
2.115
0.0355 *
st.dl1 0.004534
1.890527
0.002
0.9981
ft.dl1 0.067139
1.888691
0.036
0.9717
I
Note that ft only depends on the cointegrating vector
62 / 64
We can test whether the cointegrating vector is 0 = (1, 1) with no
intercept, i.e we want R 0 = 0 such that 1 + 2 = 0 and 3 = 0.
>
>
>
>
# test restrictions on beta

B1 <- matrix(c(1,-1,0),nrow=3)
test3 <- blrtest(z=test1,H=B1,r=1)
summary(test3)

[1] 0.0329
I
The restrictions are not rejected at 1% level

63 / 64

> # estimate restricted model
> print(model2)
$rlm
$beta
st.l1
ft.l1
constant
I
ect1
1
-1
0
The estimated cointegrating vector now satisfies the imposed

restrictions: 1 + 2 = 0 and 3 = 0
64 / 64

VAR Models and Cointegration - Sebastian Fossati

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VAR Models and Cointegration - Sebastian Fossati

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The Cointegrated VAR

In a series of important papers Soren Johansen firmly roots cointegration and

Consider the levels VAR(p) for the (n 1) vector Y t

The VAR(p) model is stable if

If Yt is cointegrated then the VAR representation is not the most

The cointegrating relations become apparent if the levels VAR is

In the VECM, Y t and its lags are I (0).

If the VAR(p) process has unit roots (z = 1) then

2. 0 < rank() = r < n. This implies that Y t is I (1) with r linearly

where and are (n r ) matrices with rank() = rank() = r . The

It is important to recognize that the factorization = 0 is not unique

Hence the factorization = 0 only identifies the space spanned by the

Example: A bivariate cointegrated VAR(1) model

Since Y t is cointegrated with one cointegrating vector, rank() = 1 so that

It is straightforward to show that 0 Y t follows an AR(1) process

The AR(1) model for ut is stable as long as

Johansens Methodology for Modeling Cointegration

The basic steps in Johansens methodology are:

Specify and estimate a VAR(p) model for Y t .

Construct likelihood ratio tests for the rank of to determine the

If necessary, impose normalization and identifying restrictions on the

Given the normalized cointegrating vectors estimate the resulting

LR Tests for the Number of Cointegrating Vectors

This nested formulation is convenient for developing a sequential procedure

These LR tests are based on the estimated eigenvalues

equal the squared canonical correlations between Y t and Y t1

Johansens Trace Statistic

The asymptotic null distribution of LRtrace (r0 ) is not chi-square but

Determining the Number of Cointegrating Vectors

Johansens Maximum Eigenvalue Statistic

Specification of Deterministic Terms

Following Johansen (1995), the deterministic terms in are restricted to the

1. Model H2 (r ): t = 0 (no constant):

4. Model H (r ): t = 0 + 1 t (restricted trend). The restricted VECM

Simulated Y t from Bivariate Cointegrated VECM

Case 3: Unrestricted constant

Case 4: Restricted trend

Case 5: Unrestricted trend

Simulated 0 Y t from Bivariate Cointegrated VECM

Case 3: Unrestricted constant

Case 4: Restricted trend

Case 5: Unrestricted trend

Johansens Cointegration Tests in R

This function considers 3 specifications for the deterministic term:

none corresponds to case 1, i.e. no constant

K is the number of lags for the VAR in levels, so K 1 is the number of

Example 1: Testing for Cointegration

iid N(0, (0.5)2 ) for i = 1, 2

# Example (1) bivariate cointegrated system

Example 1: Trace Statistic

Test finds 1 cointegrating vector

Example 1: Max Eigenvalue Statistic

Test finds 1 cointegrating vector

Example 2: Testing for Cointegration

iid N(0, (0.5)2 ) for i = 1, 2, 3

# Example (2) trivariate cointegrated system (1 coint vector)

Example 2: Trace Statistic

Test finds 1 cointegrating vector

Example 3: Testing for Cointegration

iid N(0, (0.5)2 ) for i = 1, 2, 3

# Example (3) trivariate cointegrated system (2 coint vectors)

Example 3: Trace Statistic

Values of teststatistic and critical values of test: