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Bayesian approaches to cointegration

Koop, Gary and Strachan, Rodney and Van Dijk, Herman and Villani, Mattias (2006) Bayesian approaches to cointegration. In: The Palgrave Handbook of Theoretical Econometrics. Palgrave McMillan, pp. 871-898. ISBN 1403941556

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Abstract

The degree of empirical support of a priori plausible structures on the cointegration vectors has a central role in the analysis of cointegration. Villani (2000) and Strachan and van Dijk (2003) have recently proposed finite sample Bayesian procedures to calculate the posterior probability of restrictions on the cointegration space, using the existence of a uniform prior distribution on the cointegration space as the key ingredient. The current paper extends this approach to the empirically important case with different restrictions on the individual cointegration vectors. Prior distributions are proposed and posterior simulation algorithms are developed. Consumers' expenditure data for the US is used to illustrate the robustness of the results to variations in the prior. A simulation study shows that the Bayesian approach performs remarkably well in comparison to other more established methods for testing restrictions on the cointegration vectors.