An Autoregressive Distributed Lag

Modelling
Approach to Cointegration
Analysis

M. Hashem Pesaran
Trinity College, Cambridge, ngland
!ongcheol "hin
Department o# Applied conomics, $niversity o# Cambridge, ngland
%irst &ersion' %ebruary, ())*, +evised' ,anuary,
())-
Abstract
This paper e.amines the use o# autoregressive distributed lag /A+DL0 mod1
els #or the analysis o# long1run relations 2hen the underlying variables are 3/(0.
3t sho2s that a#ter appropriate augmentation o# the order o# the A+DL model,
the 4L" estimators o# the short1run parameters are
p
T 1consistent 2ith the as1
ymptotically singular covariance matri., and the A+DL1based estimators o# the
long1run coe5cients are super1consistent, and valid in#erences on the long1run pa1
rameters can be made using standard normal asymptotic theory. The paper also
e.amines the relationship bet2een the A+DL procedure and the #ully modi6ed
4L" approach o# Phillips and Hansen to estimation o# cointegrating relations, and
compares the small sample per#ormance o# these t2o approaches via Monte Carlo
e.periments. These results provide strong evidence in #avour o# a rehabilitation
o# the traditional A+DL approach to time series econometric modelling. The
A+DL approach has the additional advantage o# yielding consistent estimates o#
the long1run coe5cients that are asymptotically normal irrespective o# 2hether
the underlying regressors are 3/(0 or 3/70.
,L Classi6cations' C(8, C(9, C(*, C88.
:ey ;ords' Autoregressive distributed lag model, Cointegration, 3/(0 and 3/70
regressors, Model selection, Monte Carlo simulation.

This is a revised version o# a paper presented at the "ymposium at the Centennial o# +agnar
%risch, The <or2egian Academy o# "cience and Letters, 4slo, March 91*, ())*. ;e are grate#ul
to Peter =os2i>?, Clive @ranger, Alberto Holly, :yung "o 3m, =rendan McCabe, "teve "atchell,
+ichard "mith, +on "mith and an anonymous re#eree #or help#ul comments. Partial 6nancial
support #rom the "+C /@rant <o. +777899A7B0 and the 3saac <e2ton Trust o# Trinity
College, Cambridge is grate#ully ac?no2ledged.
( C
(. 3<T+4D$CT34<
conometric analysis o# long1run relations has been the #ocus o# much
theoreti1 cal and empirical research in economics. 3n the case 2here the
variables in the long1run relation o# interest are trend stationary, the general
practice has been to de1trend the series and to model the de1trended series as
stationary distributed lag or autoregressive distributed lag /A+DL0 models.
stimation and in#erence concerning the long1run properties o# the model are
then carried out using stan1 dard asymptotic normal theory. /%or a
comprehensive revie2 o# this literature see Hendry, Pagan and "argan /()BD0
and ;ic?ens and =reusch /()BB00. The analysis becomes more complicated
2hen the variables are dierence1stationary, or integrated o# order ( /3/(0 #or
short0. The recent literature on cointegration is concerned 2ith the analysis o#
the long run relations bet2een 3/(0 variables, and its basic premise is, at least
implicitly, that in the presence o# 3/(0 variables the traditional A+DL approach
is no longer applicable. ConseEuently, a large number o# alternative estimation
and hypothesis testing procedures have been speci6cally developed #or the
analysis o# 3/(0 variables. /"ee the pioneering 2or? o# ngle and @ranger /()B-0,
,ohansen /())(0, Phillips /())(0, Phillips and Hansen /())70 and Phillips and
Loretan /())(0.0
3n this paper 2e re1e.amine the use o# the traditional A+DL approach #or the
analysis o# long run relations 2hen the underlying variables are 3/(0. ;e consider
the #ollo2ing general A+DL/pF E0 model'
p
y
t
G H
7
I H
(
t I
J
K
i
y
t
i
I L
7
.
EC(
I
J
L
7
5. I u F /(.(0
C
iG(
t
i
iG7
tCi t
5.
t
G P
(
5.
tC(
I P
8
5.
tC8
I 5 5 5 I P
s
5.
tCs
I M
t
F /(.80
2here .
t
is the ?1dimensional 3/(0 variables that are not cointegrated among
themselves, u
t
and M
t
are serially uncorrelated disturbances 2ith Nero means and
constant variance1covariances, and P
i
are ? O ? coe5cient matrices such that
the vector autoregressive process in 5.
t
is stable. ;e also assume that the
roots o#
P
p
iG(
K
i
N
i
G 7 all #all outside the unit circle and there e.ists a stable uniEue
long1run relationship bet2een y
t
and .
t
.
;e consider the problem o# consistent estimation o# the parameters o# the
A+DL model both 2hen u
t
and M
t
are uncorrelated, and 2hen they are corre1
lated. 3n the #ormer case 2e 2ill sho2 that the 4L" estimators o# the short1
run
parameters, H
7
, H
(
, L, L

F '''F
L

and K G /K F '''F K 0 are

p
T 1 consistent,
and
( EC( ( p
the covariance matri. o# these estimators has a 2ell1de6ned limit 2hich is as1
ymptotically singular such that the estimators o# H
(
and L are asymptotically
per#ectly collinear 2ith the estimator o# K. These results have the
interesting
P(Q
iG(
i
implication that the 4L" estimators o# the long1run coe5cients, de6ned by the
ratios R G H
(
GK/(0 and S G LGK/(0, 2here K/(0 G ( C
P
p
K
i
, converge to their
true values #aster than the estimators o# the short run parameters H
(
and L. The
9
A+DL1based estimators o# R and S are T
8
1consistent and T 1consistent,
respec1
tively. These results are not surprising and are #amiliar #rom the cointegration
literature. =ut more importantly, 2e 2ill sho2 that despite the singularity o#
the covariance structure o# the 4L" estimators o# the short1run parameters, valid
in#erences on R and S, as 2ell as on individual short run parameters, can be made
using standard normal asymptotic theory. There#ore, the traditional A+DL ap1
proach >usti6ed in the case o# trend1stationary regressors, is in #act eEually valid
even i# the regressors are 6rst1dierence stationary.
3n the case 2here u
t
and M
t
are correlated the A+DL speci6cation needs to be
augmented 2ith an adeEuate number o# lagged changes in the regressors be#ore
estimation and in#erence are carried out. The degree o# augmentation reEuired
depends on 2hether E T s I ( or not. Denoting the contemporaneous correlation
bet2een u
t
and M
t
by the ? O ( vector d, the augmented version o# /(.(0 can be
2ritten as
p
y
t
G H
7
I H
(
t I
J
K
i
y
t
i
I L
7
.
mC(
I
J
U
7
5.
I V
t
F /(.90
C
iG(
t
i
iG7
tCi
2here m G ma./EF s I (0, U
i
G L

C P
7
d, i G 7F (F 8F '''F m C (, P
7
G 3
?
,
2here
3
?
is
i
a ? O ? identity matri., L

i
G 7 #or i W E, and P
i
G 7 #or i W s. 3n
this augmented speci6cation V
t
and M
t
are uncorrelated and the results stated
above 2ill be directly applicable to the 4L" estimators o# the short1run and
long1run parameters o# /(.90. 4nce again traditional methods o# estimation and
in#erence, originally developed #or trend1stationary variables, are applicable to
6rst1dierence stationary variables. The estimation o# the short1run eects still
reEuires an e.plicit modelling o# the contemporaneous dependence bet2een u
t
and M
t
. 3n practice, an appropriate choice o# the order o# the A+DL model is
crucial #or valid in#erence. =ut once this is done, estimation o# the long1run
parameters and computation o# valid standard errors #or the resultant
estimators can be carried out either by the 4L" method, using the so1called
XdeltaY method /51method0 to compute the standard errors, or by the
=e2elyZs /()-)0 regression approach. These t2o procedures yield identical
results and a choice bet2een them is only a matter o# computational
convenience.
The use o# the A+DL estimation procedure is directly comparable to the
semi1 parametric, #ully1modi6ed 4L" approach o# Phillips and Hansen /())70
to esti1 mation o# cointegrating relations. 3n the static #ormulation o# the
cointegrating regression,
y
t
G [ I Rt I S
7
.
t
I v
t
F /(.D0
P8Q
t
2here 5.
t
G e
t
, and \
t
G /v
t
F e
7
0
7
#ollo2s a general linear stationary process, the
9
4L" estimators o# R and S are T
8
1 and T 1consistent, but in general the asymp1
totic distribution o# the 4L" estimator o# S involves the unit1root
distribution as 2ell as the second1order bias in the presence o# the
contemporaneous correla1 tions that may e.ist bet2een v
t
and e
t
. There#ore, the
6nite sample per#ormance o# the 4L" estimator is poor and in addition, due
to the nuisance parameter dependencies, in#erence on S using the usual t1
tests in the 4L" regression o# /(.D0 is invalid. To overcome these problems
Phillips and Hansen /())70 have suggested the #ully1modi6ed 4L" estimation
procedure that asymptotically ta?es account o# these correlations in a semi1
parametric manner, in the sense that the #ully1modi6ed estimators have the
@aussian mi.ture normal distribution asymp1 totically, and in#erences on the long
run parameters using the t1test based on the limiting distribution o# the #ully1
modi6ed estimator is valid.
The A+DL1based approach to estimation and in#erence, and the #ully1modi6ed
4L" procedure are both asymptotically valid 2hen the regressors are 3/(0, and a
choice bet2een them has to be made on the basis o# their small sample properties
and computational convenience. To e.amine the small sample per#ormance o# the
t2o estimators 2e have carried out a number o# Monte Carlo e.periments.
"ince in practice the XtrueY orders o# the A+DL/pF m0 model are rarely ?no2n a
priori, in the Monte Carlo e.periments 2e also consider a t2o1step strategy
2hereby p and m are 6rst selected /estimated0 using either the A?ai?e
3n#ormation Criterion /A3C0, or the "ch2arN =ayesian Criterion /"C0, and then
the long1run coe5cients and their standard errors are estimated using the
A+DL model selected in the
6rst step. ;e re#er to these estimators as A+DL1A3C and A+DL1"C. The main
6ndings #rom these e.periments are as
#ollo2s'
/i0 The A+DL1A3C and the A+DL1"C estimators have very similar small1sample
per#ormances, 2ith the A+DL1"C per#orming slightly better in the ma>ority
o# the e.periments. This may re]ect the #act that the "ch2artN criterion
is a consistent model selection criterion 2hile A?ai?e is not.
/ii0 The A+DL test statistics that are computed using the 51method /or eEuiv1
alently by means o# the so1called =e2leyZs regression0, generally per#orm
much better in small samples than the test statistics computed using
the asymptotic #ormula that e.plicitly ta?es account o# the #act that the
regres1 sors are 3/(0.
/iii0 The A+DL1"C procedure 2hen combined 2ith the 51method o# comput1
ing the standard errors o# the long1run parameters generally dominates the
Phillips1Hansen estimator in small samples. This is in particular true o# the
siNe1po2er per#ormance o# the tests on the long1run parameter.
P9Q
u
/iv0 The Monte Carlo results point strongly in #avor o# the t2o1step estimation
procedure, and this strategy seems to 2or? even 2hen the model under con1
sideration has endogenous regressors, irrespective o# 2hether the regressors
are 3/(0 or 3/70.
(
The plan o# the paper is as #ollo2s' "ection 8 e.amines the asymptotic prop1
erties o# the 4L" estimators in the conte.t o# a simple autoregressive model 2ith
a linear deterministic trend and the ?1dimensional strictly e.ogenous 3/(0 regres1
sors. "ection 9 considers a more general A+DL model, allo2ing #or residual serial
correlations and possible endogeneity o# the 3/(0 regressors, and develops the re1
sultant asymptotic theory. 3n "ection D the A+DL1based approach is compared
to the cointegration1based approach o# Phillips and Hansen /())70. "ection *
reports and discusses the results o# Monte Carlo e.periments. "ome concluding
remar?s are presented in "ection A. Mathematical proo#s are provided in an
Appendi..
8. The Lagged Dependent &ariable Model 2ith the
Deter1 ministic Trend and .ogenous 3/(0 +egressors
3nitially 2e consider the simple A+DL/(,70 model containing 3/(0 regressors and
a linear deterministic trend,
K/L0y
t
G H
7
I H
(
t I L
7
.
t
I u
t
F t G (F '''F T F /8.(0
2here y
t
is a scalar, K/L0 G ( C KL, 2ith L being the one period lag operator, .
t
is a ? O ( vector o# regressors assumed to be integrated o# order ('
8
.
t
G .
tC(
I e
t
F /8.80
and L is a ? O ( vector o# un?no2n parameters. "uppose that the #ollo2ing
assumptions hold'
/A(0 The scalar disturbance term, u
t
, in /8.(0 is iid/7F ^
8
0,
(
The case 2here the regressors are 3/(0 and cointegrated among themselves presents ad1
ditional identi6cation problems and is best analyNed in the conte.t o# a system o# long1run
structural eEuations. 4n this see Pesaran and "hin /())*0.
8
"peci6cations /8.(0 and /8.80 can easily be adapted to allo2 #or inclusion o# a dri#t term in
the .
t
process. Consider, #or e.ample, the process 5.
t
G [
.
I e
t
F and note that it can also be
2ritten as .
t
G [
.
t I ._
t
, 2here 5._
t
G e
t
' There#ore, substituting .
t
in /8.(0 2e have
K/L0y
t
G H
7
I /H
(
I L
7
[
.
0t I L
7
._
t
I
u
t
F
2here ._
t
#ollo2s an 3/(0 process 2ithout a dri#t.
PDQ
C t t
`
C
/A80 The ?1dimensional vector, e
t
, in /8.80 has a general linear multivariate
stationary process,
/A90 u
t
and e
t
are uncorrelated #or all leads and lags such that .
t
is strictly
e.ogenous 2ith respect to u
t
,
/AD0 The 3/(0 regressors, .
t
, are not cointegrated among themselves, and
/A*0 >K> a (, so that the model is dynamically stable, and a long1run relationship
bet2een y
t
and .
t
e.ists.
9
;e shall distinguish bet2een t2o types o# parameters, the parameters
capturing the short1run dynamics /H
7
F H
(
F L and K0, and the long run
parameters on the trended regressors, t and .
t
, de6ned by
R G
H
(
( C K
F S G
L
( C
K
' /8.90
Applying the decomposition ( C KL G /( C K0 I K/( C L0 to /8.(0, y
t
can
be e.pressed as
2here
y
t
G [ I Rt I S
7
.
t
I v
t
F /8.D0
and
[ G
H
7
( C
K
(
S
K
b
RF
( C
K
(
v
t
G
J
K
i
u
t i
C K
J
K
i
S
7
e ' C
iG7 iG7
tCi
%rom /8.(0 and /8.D0 it is clear that y
t
and .
t
are individually 3/(0, but must be
cointegrated #or /8.(0 to be meaning#ul.
D
"imilarly, 2e obtain
y
tC(
G [
(
I Rt I S
7
.
t
I `
t
F /8.*0
2here [
(
G [ C R, `
t
G v
t (
C S
7
e , and ` is an 3/70 process 2ith variance ^
8
.
4ur main aim is to derive the asymptotic properties o# the 4L" estimators o#
the short1run as 2ell as the long1run parameters in the conte.t o# the A+DL/(,70
9
Tests o# the e.istence o# long1run relationships bet2een y
t
and .
t
, 2hen it is not ?no2n a
priori 2hether .
t
are 3/70 or 3/(0, are discussed in Pesaran, "hin and "mith /())A0.
D
A relationship bet2een 3/(0 variables is said to be Xstochastically cointegratedY i# it is trend
stationary, 2hile Xdeterministic cointegrationY re#ers to the case 2here the cointegrating relation
is level stationary. %or a discussion o# these t2o types o# cointegrating relations see Par? /())80.
P*Q
^
^
8
uT
/P
uT T
8
c
T
model, /8.(0. %or e.positional convenience, 2e trans#orm /8.(0 to the partitioned
regression model in the matri. #orm as,
y
T
G c
T
b I y
T C(
K I u
T
F /8.A0
2here y
T
G /y
(
F '''F y
T
0
7
, y
T C(
G /y
7
F '''F y
T C(
0
7
, d
T
G /(F '''F (0
7
, t
T
G /(F '''F T
0
7
, J
T
G /.
(
F '''F .
T
0
7
, c
T
G /d
T
F t
T
F J
T
0, u
T
G /u
(
F '''F u
T
0
7
, and b G /H
7
F H
(
F
L
7
0
7
. "ince our main interest is in the long1run coe5cients on trended regressors, t
and .
t
, 2e also partition
c
T
G /d
T
F "
T
0F "
T
G /t
T
F J
T
0F b G
S
H
7
c
b
F c G
S
H
(
b
F
L
2here the dimensions o# c
T
, "
T
, b and c are T O /? I 80, T O /? I (0, /? I 80 O
(
and /? I (0 O (, respectively.
Theorem 8.(. $nder the assumptions /A(0 1 A/*0, the 4L" estimators o# K and
c G /H
(
F L
7
0
7
in /8.A0, denoted by K
e
T
and ec
T
, respectively, are
p
T 1consistent,
and
have the #ollo2ing asymptotic distributions'
p
a
f
^
8
^
T /K
e
T
C K0 \
<
7F
u
`
F /8.-0
p
a
f
^
8
^
T /ec
T
C c0 \
<
7F
u
WW
7
`
F /8.B0
2here W G /RF S
7
0
7
is a /? I (0 O ( vector o# the long run parameters on trended
regressors, t and .
t
, and ran?/WW
7
0 G (. 3n addition, the 4L" estimator o#
H
7
in /8.A0, denoted by He
7T
, is also
p
T 1consistent, but has the mi.ture
normal
distribution. De6ning h G /b
7
F K0
7
and P
c
T
G /c
T
F y
T C(
0, and denoting the
4L"
estimator o# h by h
e
T
, the covariance matri. o# h
e
T
can be consistently
estimated
by
&
e
/h
e
T
0 G ^e
8 7
P
c
T
0
C(
F
2here
^e
8
G T
C(
/y
T
C
P
c
h
e
T
0
7
/y
T
C
P
c
T
h
e
T
0, and &
e
/h
e
T
0 is asymptotically
sin1
gular 2ith ran? eEual to 8.
Theorem 8.( sho2s that despite the presence o# stochastic and deterministic trends
in the A+DL model, the 4L" estimators o# the short1run parameters are
p
T 1 consistent.
*
The second and more important 6nding is that the 4L" estimators
*
"imilar results can also be obtained in the case o# regressors 2ith higher order trend terms
such as t
8
F t
9
F '''F or 3/80, 3/90, ..., variables.
PAQ
T
C W G
/( K 0
9
e
u
T
9
R
T
L
L
L
(
9
o# the coe5cients on the trended regressors, H
(
and L, in /8.(0 are asymptoti1
cally per#ectly collinear 2ith the 4L" estimator o# the coe5cient on the lagged
dependent variable, KF namely,

T
n o p
/ec
T
C c0 I
W/K
e
C K
0
G o
p
/(0' /8.)0
4ne interesting implication o# this result is that the t1statistics #or testing the
sig1 ni6cance o# individual impact coe5cients on the 3/(0 regressors are
asymptotically
A
eEuivalent, namely t
e
i
C t
L
e
>
G o
p
/(0 #or i G >, and
t
e
i
C t
He
(
G o
p
/(0.
%urthermore,
t
e
i
C t
/(CK
e
0
G o
p
/(0. +elation /8.)0 in con>unction
2ith
W
e
/ec
T
C c0 I W/K
e
T
C
K0
C
e
T
F /8.(70
also yields an important result #amiliar #rom the cointegration literature, 2hich
2e set out in the #ollo2ing theorem'
Theorem 8.8. $nder assumptions /A(0 1 /A*0, the A+DL1based estimators o#
the long1run parameters, given by
e
R
T
G He
(T
G/( C K
e
T
0, and S
e
T
G L
e
T
G/( C K
e
T
0, converge to their true values R and S, respectively, at the rates, T
8
and T . Also
9
asymptotically, T
8
/R
T
CR0 and T /S
e
T
CS0 have the /mi.ture0 normal
distributions,
and there#ore,
g
8 C(
e
a
f

^
8

^
"
_
T
D
"
T
/W
T
C W0 \
<
7F
/( C
3
?I(
K0
8
F /8.((0
2here W
e
T
G /
e
R
T
F S
e
7
0
7
,
g
_
G D
"
"
7
H
T
"
T
D
"
F "
T
G /t
T
F J
T
0, H
T
G 3
T
C
T "
T
T T T
( 7 C C(
d
T
/d
7
d
T
0
C
d
T
F and D
"
T
G Diag/T
8
F T 3
?
0'
The 6nding that the estimator o# S is T 1consistent is ?no2n as the Xsuper1
consistencyY property in the cointegration literature. "ince the limiting
distri1
butions o# T
8
/
e
R
T
C R0 and T /S
e
T
C S0 are /mi.ture0 normal, optimal t2o1
sided
in#erences concerning and S are possible. <otice also that the covariance matri.
o# the estimator o# W simply depends on the inverse o# the /scaled0 demeaned
data matri. and the spectral density at Nero #reEuency o# /( C KL0
C(
u
t
,
namely
^
8 8
u
G/( C K0 . 4nce again, this 6nding is in line 2ith the results already #amiliar
L
#rom the cointegration literature. /"ee "ection D #or #urther discussions.0
A
%or large enough T 2e have t
e
i
U /( C K0 /^
`
G^
u
0 ' This e.plains the relatively lo2 t1ratios
o#ten obtained #or short1run coe5cients in A+DL regressions 2ith 3/(0 variables, especially 2hen
K is close to unity.
P-Q
^
e
T

i
T ii
Hypothesis testing on the general linear restrictions involving the ? I ( di1
mensional long1run parameter vector, W, can be carried out in the usual manner.
Consider the g linear restrictions on W,
+W G rF
2here + is a g O /? I (0 matri. and r is a g O ( vector o# ?no2n constants. These
restrictions can be tested using the ;ald statistic,
C(
; G /+W
e
T
C r0
7
n
+Cov/W
e
T
0
+
7
o
/+W
e
T
C r0 /8.(80
G /+W
e
T
C
r0
7
/
/( C
K
e
T
8
uT
0
8
0
/"
7
H
T
"
T
0 /+W
e
T
C r0'
4# special interest is the t1statistic on the individual coe5cients given by
W
e
iT
C
W
i
t
i
G
se
i
F i G (F '''F ? I (F /8.(90
2here the standard error o# the i1th coe5cient is consistently estimated by
se
i
G
s
^e
8
uT
/"
7
H
T
"
T
0
C(
F
/( C K
e
T
0
8
and /"
7
H
T
"
T
0
C(
denotes the i1th diagonal element o# /"
7
H
T
"
T
0
C(
. =y Theorem
T ii T
8.8, the ;ald statistic in /8.(80 #ollo2s the asymptotic h
8
distribution 2ith g
degrees o# #reedom, and t
8
in /8.(90 is distributed asymptotically as a h
8
variate
2ith one degree o# #reedom.
3t is 2orth noting that the results in Theorem 8.8 eEually apply to the purely
autoregressive model 2ith deterministic trend,
y
t
G H
7
I H
(
t I Ky
tC(
I u
t
F t G (F '''F T F /8.(D0
and to the A+DL/(,70 model 2ithout a deterministic trend,
y
t
G H
7
I L
7
.
t
I Ky
tC(
I u
t
F t G (F '''F T ' /8.(*0
%or completeness the asymptotic results #or these models are summariNed in
The1
orems 8.9 and 8.D.
Theorem 8.9. $nder the assumptions /A(0 and /A*0, the 4L" estimators o#
H
7
F H
(
and K in /8.(D0, denoted by He
7T
, He
(T
, and K
e
T
,are all
p
T 1consistent,
and asymptotically normally distributed. 3n addition,
p
T /He
(T
C H
(
0 and
p
T
/K
e
T
C K0
PBQ
u
u
/( C K
e
T
0
8
P
T
u
(
(
(
are per#ectly collinear asymptotically and the covariance matri. o# /He
7T
, He
(T
,
K
e
T
0 is asymptotically singular 2ith ran? eEual to 8. %urthermore, the estimator
o# the long run parameter R, computed by He
(T
G/( C K
e
T
0, has the #ollo2ing
asymptotic distribution'
9
a
f
(8^
8
^
T
8
/
e
R
T
C R0 \
<
7F
u
/( C
K0
8
' /8.(A0
Theorem 8.D. $nder assumptions /A(0 1 /A*0, the 4L" estimators o# H
7
F L and
K in /8.(*0, denoted by He
7T
, L
e
T
, and K
e
T
are
p
T 1consistent, and have the
asymp1 totic /mi.ture0 normal distributions. 3n addition,
p
T /He
(T
C H
(
0 and
p
T /K
e
T
C K0
are per#ectly collinear asymptotically and so the covariance matri. o# /He
7T
,
L
e
T
, K
e
T
0 is asymptotically singular 2ith ran? eEual to 8. %urthermore, the
estimator o# the long run parameter S, given by S
e
T
G L
e
T
G/( C K
e
T
0F has the
mi.ture normal
distribution asymptotically, and
g
8
e
a
f

^
8

^
J
_
T
T /S
T
C S0 \
<
8 7
7F
/( C
3
?
K0
8
F /8.(-0
2here g
J
_
T
G T
C
J
T
H
T
J
T
'
=e#ore considering a more general speci6cation o# the A+DL model, 2e e.amine
the relation bet2een the standard errors o# the estimator o# the long1run para1
meter, S, obtained #rom our asymptotic results and the standard errors obtained
#rom the so called XdeltaY method /51method #or short0. %or ease o# e.position
2e consider the simple model /8.(*0, and 2ithout loss o# generality #ocus on the
case 2here .
t
is a scalar /i.e., ? G (0. %rom Theorem 8.D 2e have
g
8
e
( M
T
i
8
J
8
e
a
f

^
8

^
J
_
T
T /S
T
C S0 G
8
P
T
tG(
/.
t
C
.[0
8
/S
T
C S0 \
<
C(
P
T
7F
/( C
-
K0
8
F /8.(B0
2here g
J
_
T
G T
C
tG(
/.
t
C
.[0
and .[ G
T
tG(
.
t
. Hence a consistent
estimator o# the variance o#
e
S
T
is given by
^e
8
(
&
e
/
e
S
T
0 G
uT
' /8.()0
T
tG(
/.
t
C .[0
8
-
3n the case 2here .
t
is 3/70 2e have the same asymptotic result given by /8.(B0F that is,
since T
C(
.
7
H
T
.
T
G 4
p
/(0 and
p
T /
e
S
T
C S0 G 4
p
/(0, hence
/T
C(
.
7
8
p
( M
T
i
8
J
8
a
f

^
8

^
T
H
T
.
T
0 T /
e
S
T
C S0
G
tG(
/.
t
C
.[0
/
e
S
T
C S0 \
<
7F
/( C
K0
8
'
P)Q
7
^
e
T
C
^
e
t
C S
0
t
C S
0
._ 0
/
T
uT
8
P P
T
/
8
The computation o# the variance o#
e
S
T
by the 51method involves appro.imating
L
e
T
T
G g/j
e
T
0 G F
( C K
e
T
by a linear #unction o# j
e
T
G /L
e
T
F K
e
T
0
7
, and then appro.imating the variance o#
e
S
T
by the variance o# the resulting linear #unction. Denoting the estimator o# the
variance o#
e
S
T
by &
e
5
/
e
S
T
0, 2e have
&
e
5
/
e
S
T
0
G
k
l g /j
e
T
0
m
&
e
/j
e
T
0
k
l g /j
e
T
0
m
lj
e
T
M
( L
e
T
lj
e
T
i
8
(
9
(CK
e
T
G F
( C K
e
T
/( C K
e
T
0
8
8
/+
7
H
T
+
T
0
C(
A
D
-
F
L
e
T
*
/(CK
e
T
0
8
2here +
T
G /.
T
F y
T C(
0. A#ter some algebra &
e
5
/
e
S
T
0 can be e.pressed as
^e
8
h i
(
` P
/y
t (
C y[0
8
C
P
/y C y[0
/.
C .
[0
W `
(
W
&
e
5
/
e
S
T
0 G
uT
(F
e
S
T
C tC( t
F
/( C K
e
T
0
8
D
T
C
P
/y
tC(
C y[0/.
t
C .[0
P
/.
t
C
.[0
T
/8.870
2here the bar over the variable denotes the sample mean, and
D
T
G
M
T
J
/.
t
C
.[0
8
tG(
i M
T
J
/y
t
tG(
i
(
C
y[0
8
M
T
C
J
/y
tG(
tC(
C y[0
/.
t
i
8
C .[0 '
$sing /8.*0, recalling that R G 7 and de6ning y_
tC(
G y
tC(
C y[F ._
t
G .
t
C .[ and
`_
t
G `
t
C `[, 2e also have
y_
tC(
G S._
t
I `_
t
F /8.8(0
2here `_
t
#ollo2s a general linear stationary process. "ubstituting this result in
/8.870, 2e obtain
8
&
e
5
/ 0 G
uT
P
T
tG(
`_
8
I
/
8
T
T
tG(
._
8
C
8/
T
T
tG(
._
t
`_
t
' /8.880
/( C K
e
T
0
8
P
T
8
P
tG(
t
tG(
`_
t
0 C
/
P
T
tG(
._
t
`_
t
0
8
"ince `_
t
is 3/70 and ._
t
is 3/(0, using the results #amiliar in the literature /see,
#or e.ample, Phillips and Durlau# /()BA00, 2e have
T T T
T
C(
J
`_
8
G 4
p
/(0F T
C8
J
._
8
G 4
p
/(0F T
C(
J
._
t
`_
t
G 4
p
/(0'
t
tG (
t
tG( tG(
P(7Q
/( C K0
8
T
C8
P
T
tG(
u
Also #rom the result o# Theorem 8.D 2e ?no2 that T /
e
S
T
C S0 G 4
p
/(0.
Hence, ta?ing probability limits o# the right hand side o# /8.880 as T m (, 2e
have
^
8
(
&
e
5
/
T
0 G
u
I o
p
/(0'
tG(
/.
t
C .[0
8
There#ore, the standard error #or the estimator o# the long run parameter, S,
obtained using the 51method is asymptotically the same as that given by /8.()0,
2hich 2as derived assuming that .
t
is 3/(0. 4ne important advantage o# the
variance estimator obtained by the 51method over the asymptotic #ormula /8.()0
lies in the #act that it is asymptotically valid irrespective o# 2hether .
t
is 3/(0 or
3/70, 2hile the latter estimator is valid only i# .
t
is 3/(0.
The t2o variance estimators clearly dier in 6nite samples. <otice that /
P
T
._
t
`_
t
0
8
is asymptotically negligible compared to other terms in /8.880, but it may not be
negligible in 6nite samples, especially 2hen ._
t
and `_
t
are correlated. %or a
com1 parison o# the small sample properties o# the t2o variance estimators
see the Monte Carlo results reported in "ection *.
9. @eneral Autoregressive Distributed Lag Models 2ith
a
Deterministic Trend and 3/(0 +egressors
"o #ar 2e have derived the estimation and asymptotic results #or the simple
A+DL/(,70 model under the t2o strong assumptions /A(0 and /A90. These as1
sumptions, ho2ever, are too restrictive in the time series analysis, and so the
estimation procedures developed in "ection 8 are not e.pected to be robust to
the violation o# these assumptions, because the limiting distributions o# the 4L"
estimators 2ould then be inconsistent andnor depend on nuisance parameters.
;e 6rst rela. the assumption /A(0 and allo2 #or the possibility o# the error
process in /8.(0 to be serially correlated. To deal 2ith this serial correlation 2e
consider the A+DL/pF E0 model,
B
K/L0y
t
G H
7
I H
(
t I L
7
/L0.
t
I u
t
F /9.(0
2here K/L0 G ( C P
p
K L
>
, and L/L0 G
P
E
L L
>
, and assume
> G( > >G7 >
/A(0
7
The scalar disturbance, u
t
F in the A+DL/pF E0 model /9.(0 is iid/7F ^
8
0.
B
%or convenience 2e use the same notation u
t
#or the disturbance terms in /8.(0 and /9.(0. 3n
practice the order o# the lag polynomials operating on dierent elements o# .
t
could be dierent.
=ut this does not aect the asymptotic theory presented belo2.
P((Q
>G7
K
>
G
C C C
>
G
$sing the decomposition L/L0 G L/(0 I /( C L0L

/L0, 2here L/(0 G
P
E
L
>
F
L

/L0 G
P
EC(
L

L
>
and L

G C
P
E
L F /9.(0 can be re2ritten as
>G7 > > iG> I( i
EC(
K/L0y
t
G H
7
I H
(
t I L
7
.
t
I
J
L
7
5.
t
>
I u F /9.80
>
C t
>G7
2here 2e have used L G L/(0. "imilarly, applying the decomposition K/L0 G
K/(0 I /( C L0K

/L0 to /9.80, 2here K/(0 G ( C
P
p
K F K

/L0 G
P
pC(
K

L
>
and
iG( i
p
>G7 >
P
iG> I(
K
i
F 2e have
EC(
K/(0y
t
G H
7
I H
(
t I L
7
.
t
I
J
L
7
5.
t
>
C K

/L05y I u ' /9.90

Also #rom /9.(0, 2e obtain
>
C t t
> G7
5y
t
G PK/L0Q
C(
#H
(
I L
7
/L05.
t
I 5u
t
g'
"ubstituting #or 5y
t
in /9.90 2e have
y
t
G [
7
IRtIS
7
.
t
I
2here
o
L

/L0 K

/L0 PK/L0Q
C(
L/L0
j
7
5.
t
I
K/(0
o
( /( L0K

/L0 PK/L0Q
C(
j
u
t
F
K/(0
/9.D0
H
7
C K

/(0R H
(
L
[
7
G
<o2 it is easily seen that
F R G F S G S/(0 G '
K/(0 K/(0
K/(0
(
and
/( C L0L

/L0 C /( C L0K

/L0
PK/L0Q
C
K/(0
L/L0
G S/L0 C SF
( C /( C L0K

/L0 PK/L0Q
C(
K/(0
( C #K/L0 C K/(0g PK/L0Q
C(
K/(0
G PK/L0Q
C(
F
2here S/L0 G L/L0GK/L0. $sing these results and the decomposition S/L0 G
S/(0 I /( C L0S

/L0, 2here S

/L0 G
P
(
S

L
>
and S

G C
P
(
S
i
in /9.D0 2e
obtain
> G7 > > iG>I(
(
y
t
G [
7
I Rt I S
7
.
t
I S
7
/L05. I
PK/L0Q
C
u
t
' /9.*0
Matching the regressors on the right1hand1side o# /9.80 2ith those in /9.*0 2e
6nally obtain
EC(
y
t
G [
7
I Rt I S
7
.
t
I
J
S
7
5.
t
C>
I `
7t
F /9.A0
> G7
P(8Q
>GE >
C
i>
S

T
uT
/P
8
@
T
(
2here `
7t
G
P
(
S
7
e
t >
I PK/L0Q
C(
u
t
. "imilarly,
EC(
J
y
tCi
G [
i
I Rt I S
7
.
t
I
2here [
i
G [
7
C iR, i G (F '''F pF
> G7
g
7
5.
tC>
I `
it
F i G (F '''F pF /9.-0
and
g
i>
G
f
CS i# i T >
^
F 7 >
> C(
i# i ` >
`
` E C(F i G (F '''F pF
/
P
(
S
7
e
t i >
I PK/L0Q
C(
u #or i ` E
0
`
it
G
>GECi >
C C
CS
7
P
iCEC( 7
tCi
C(
' /9.B0
>G7
e
tCEC>
I S /L0e
tCi
I PK/L0Q u
t
#or i T E
As in the previous section, 2e re2rite the A+DL/pF E0 model /9.80 in matri.
notations in the partitioned regression #orm,
y
T
G @
T
# I !
T
K I u
T
/9.)0
G H
7
d
T
I "
T
c I ;
T
L

I !
T
K I u
T
F
2here y
T
G /y
(
F '''F y
T
0
7
, y
TFCi
G /y
(Ci
F '''F y
T Ci
0
7
F #or i G (F '''F pF !
T
G /y
TFC(
F '''F y
TF
Cp
0F
5J
TFC>
G /5.
(C>
F '''F 5.
T C>
0 #or > G 7F '''F EC(F ;
T
G /5.
TF7
F 5.
TFC(
F '''F 5.
TFCEI(
0F
d
T
G /(F '''F (0
7
, t
T
G /(F '''F T 0
7
, J
T
G /.
(
F '''F .
T
0
7
, @
T
G /d
T
F t
T
F J
T
F ;
T
0 G
/d
T
F "
T
F ;
T
0, u
T
G /u
(
F '''F u
T
0
7
, # G /H
7
F c
7
F L
7
0
7
, c G /H
(
F L
7
0
7
, L

G /L
7
F '''F L
7
0
7
7 EC(
and K G /K
(
F '''F K
p
0
7
' <ote that the dimensions o# !
T
, @
T
, K and # are T O pF T O
/? I ?E I 80F p O ( and /? I ?E I 80 O (, respectively.
Theorem 9.(. $nder assumptions /A(0
7
and /A80 1 /A*0, the 4L" estimators o#
K and c G /H
(
F L
7
0
7
in the A+DL/pF E0 model /9.)0 are
p
T 1consistent and have
the #ollo2ing asymptotic distributions'
p
a
o j
T /K
e
T
C K0 \
<
7F ^
8
g
C(
F /9.(70
u :
2here g
:
is the pOp positive de6nite covariance matri. o# /`
(t
F `
8t
F '''F `
pt
0
7
de6ned
by /9.B0, and
p
a
o j
T /ec
T
C c0 \
<
7F ^
8
d
7
g
C(
d
p
WW
7
F /9.((0
u p :
2here W G /RF S
7
0
7
, d
p
is the p1dimensional unit vector, and ran?/WW
7
0 G (. The
4L" estimators o# H
7
and L

, denoted by He
7T
and L
e

F are also
p
T 1consistent, and
have the mi.ture normal distributions, asymptotically. The covariance matri. #or
all the short1run parameters, h G /#
7
F K0
7
, is asymptotically singular 2ith ran?
eEual to ?E I 8, and can be consistently estimated in the usual 2ay by
&
e
/h
e
T
0 G ^e
8 7
P
@
T
0
C(
F
2here P
@
T
G /@
T
F !
T
0F and ^e
uT
G
T
C
/y
T
C P
@
T
h
e
T
0
7
/y
T
C P
@
T
h
e
T
0.
P(9Q
2here K
e
T
/(0 G ( C
P
T
u
u
^
iG(
T
T
(
u
%rom Theorem 9.( 2e also 6nd that
p
T /He
(T
C H
(
0 and
p
T /L
e
T
C L0 are
asymp1 totically per#ectly collinear 2ith
p
T /K
e
T
C K0F that is,
T
n o p
/ec
T
C c0 I
WPK
e
/(0 C
K/(0Q
G o
p
/(0' /9.(80
p
iG(
K
e
i
T
. 3t is also straight#or2ard to sho2 that
/ec
T
C c0 I WPK
e
T
/(0 C K/(0Q
W
e
T
C W G
K
e
T
/(0
' /9.(90
$sing Theorem 9.(, and results /9.(80 and /9.(90, 2e have'
Theorem 9.8. $nder the assumptions /A(0
7
and /A80 1 /A*0, the 4L" estimators
o# the long1run parameters,
W
e
T
G /
e
R
TF
S
e
7
0
7
G
ec
T
GK
e
/(0 in /9.)0, converge to
their true values at #aster rates than the estimators o# the associated short1run
parameters, and #ollo2 the mi.ture normal distribution asymptotically. There#ore,
g
8
C(
e
a
f

^
8

^
"
_
T
D
"
T
/W
T
C W0 \
<
7F 3
?I(
PK/(0Q
8
F /9.(D0
2here g
"
_
T
and D
"
T
are as de6ned in Theorem
8.8.
Comparing Theorems 8.8 and 9.8, 2e 6nd that the presence o# the 3/70 stationary
regressors in /9.)0 /i.e., additional lagged changes in y
t
and the lagged changes
in .
t
2hich are introduced to deal 2ith the residual serial correlation problem0
does not aect the asymptotic properties o# the 4L" estimator o# the long run
coe5cients, R and S. There#ore, in#erences concerning the long1run parameters
can be based on the same standard tests as given by /8.(80 and /8.(90. 3n this
more general case, ho2ever, the e.pression #or the asymptotic variance o# W
e
T
is still given by /8.((0, but 2ith ^
8
G/( C K0
8
replaced by the more general
e.pression,
8
GPK/(0Q
8
.
;e no2 rela. assumption /A90 and allo2 #or the possibility o# endogenous
regressors, but con6ne our attention to the case 2here 5.
t
can be represented by
a 6nite order vector A+/s0 process,
)
2here P/L0 G 3
?
C
P
s
P/L05.
t
G M
t
F /9.(*0
P
i
, and P
i
, i G (F '''F s, are the ? O ? coe5cient matrices
such that the vector autoregressive process in 5.
t
is stable. Here M
t
are assumed
)
4ur analysis can also allo2 #or the inclusion o# lagged 5yZs and a dri#t term in /9.(*0 2ithout
aecting the results presented belo2. 4n this see =os2i>? /())*0 and Pesaran, "hin and "mith
/())A0.
P(DQ
t
^
>

V
to be serially uncorrelated, but possibly contemporaneously correlated 2ith u
t
F
namely, 2e assume that p
t
G /u
t
F M
7
0
7
#ollo2s the multivariate iid process
2ith mean Nero and the covariance matri.,
`
8
q
pp
G
u
q
uM
W
' /9.(A0
q
Mu
q
MM
;e 2ill, ho2ever, continue to assume that Cov/u
tC>
F M
tCi
0 G 7 #or i G >. <o1
tice that despite this assumption the model is still general enough to allo2
not only #or the contemporaneous but also #or cross1autocorrelations bet2een u
t
and
5.
t
. ;ith assumption /A90 rela.ed, the 4L" estimators in /9.(0 are no longer
consistent. To correct #or the endogeneity o# .
t
, 2e model the
contemporaneous
correlation bet2een u
t
and M
t
by the linear regression o# u
t
on M
t
u
t
G d
7
M
t
I V
t
F /9.(-0
2here using /9.(A0 2e have d G q
C(
q
7
, and M
t
is strictly e.ogenous 2ith respect
MM uM
to V
t
.
(7
"ubstituting /9.(*0 in /9.(-0 2e obtain'
u
t
G d
7
P/L05.
t
I V
t
F /9.(B0
2here 5.
tCi
Zs, i G 7F '''F sF are also strictly e.ogenous 2ith respect to V
t
. The
parametric correction #or the endogenous regressors is then eEuivalent to
e.tending the A+DL/pF E0 model /9.80 to the more general A+DL/pF m0 speci6
cation,
mC(
K/L0y
t
G H
7
I H
(
t I L
7
.
t
I
J
U
7
5.
t
C>
I V
t
F /9.()0
>G7
2here m G ma./EF s I (0, and U
i
G L

C P
7
d, i G 7F (F 8F '''F m C (, P
7
G 3
?
,
i i
L
i
G 7 #or i W E, and P
i
G 7 #or i W s.
;e no2 replace assumption /A90 by
/A90
7
The scalar disturbance V
t
in /9.()0 is iid/7F ^
8
0, and 5.
t
#ollo2s the general
stationary process given by /9.(*0. %urthermore, V
t
and M
t
are uncorrelated
such that .
t
and 5.
tC>
Zs > G 7F '''F m C (F are strictly e.ogenous 2ith
respect to V
t
in the A+DL/pF m0 model /9.()0.
There are t2o main dierences bet2een the A+DL models de6ned by /9.80 and
/9.()0. %irstly, the order o# lagged 5.
t
Zs in the t2o models can dier, and
secondly, the coe5cients on 5.
t
Zs and their lagged values have dierent
interpretations. Although this alters the dynamic structure o# the model, the basic
#rame2or? #or estimating the long1run parameters and carrying out statistical
in#erence on them is the same as be#ore.
(7
The relation /9.(-0 2ill be e.act 2hen the >oint distribution o# u
t
and M
t
is normal.
P(*Q
K
T
iG(
T
^
V
> >
(
f
V
C
Theorem 9.9. $nder the assumptions /A90
7
, /AD0 and /A*0, the 4L" estimators
p
o# the short1run parameters in /9.()0, H
7
, H
(
, L, K
(
F '''F K
p
, U
7
F '''F U
mC(
, are T 1
consistent, and asymptotically have the /mi.ture0 normal distributions. %urther1
i
more,
p
T /ec
T
C c0 is asymptotically per#ectly collinear 2ith
p
T h
e
/(0 C K/(0 ,
2here c G /H
(
F L
7
0
7
and K/(0 G ( C
P
p
K
i
, such that the covariance matri. #or
the estimators o# the short1run parameters is asymptotically singular 2ith ran?
eEual to ?m I 8. The asymptotic distribution o# the 4L" estimators o# the long1
run parameters,
there#ore,
W
e
T
G
/
TF
S
e
7
0
7
G
ec
T
GK
e
T
/(0 in /9.()0, are mi.ture normal and
g
8 C(
e a
8
^
"
_
T
D
"
T
/W
T
C W0 \
<
7F 3
?I(
PK/(0Q
8
F /9.870
2here ^
8
is the variance o# V
t
in /9.()0, and g
"
_
T
and D
"
T
are as de6ned in
Theorem 8.8.
There are no #undamental dierences bet2een the results o# Theorems 8.8,
9.8 and 9.9, as #ar as the estimators o# the log1run parameters are concerned. A
com1 parison o# /8.((0, /9.(D0 and /9.870 sho2s that the asymptotic distributions o#
the
estimators o# the long1run parameters, W
e
T
, under various assumptions
discussed
above dier only by a scalar coe5cient.
3n sum, in the conte.t o# the A+DL model in#erence on the long run para1
meters, R and S, is Euite simple and reEuires a priori ?no2ledge or estimation o#
the orders o# the e.tended A+DL/pF m0 model. Appropriate modi6cation o# the
orders o# the A+DL model is su5cient to simultaneously correct #or the resid1
ual serial correlation and the problem o# endogenous regressors. &ariances o# the
4L" estimators o# the long1run coe5cients can then be consistently estimated
using either /9.870, or by means o# the 51method applied directly to the long1
run estimators. Alternatively, one could compute the estimates o# the long1run
coe5cients and their associated standard errors using =e2leyZs /()-)0 regression
procedure. =e2leyZs method involves re2riting /9.()0 as
H
7
(
mC(
J
p (
(
J
V
t
K/L0y
t
G
K/(0
I Rt I S
7
.
t
I
K/(0
>G7
U
7
5.
tC>
C
K/(0
>G7
K

5y
tC>
I
K/(0
F /9.8(0
and then estimating it by the instrumental variable method using /(, t, .
t
, 5.
t
,
5.
tC(
F '''F 5.
tCmI(
, y
tC(
, y
tC8
F '''F y
tCp
0 as instruments. 3t is easy to sho2 that
the
3& estimators o# R and S obtained using /9.8(0 are numerically identical to the
4L" estimators o# R and S based on the A+DL model /9.()0, and that the standard
errors o# the 3& estimators #rom the =e2leyZs regression are numerically identical
to the standard errors o# the 4L" estimators o# R and S obtained using the 51
method. /"ee, #or e.ample, =ardsen /()B)0.0 The main attraction o# the =e2leyZs
P(AQ
regression procedure lies in its possible computational convenience as compared to
the direct 4L" estimation o# /9.()0 and computation o# the associated standard
errors by the 51method.
((
%inally, 2e note in passing that the results developed in this section also apply
to the case 2here the underlying regressors, .
t
, given by /9.(*0, are 3/70. /"ee
#ootnote - and the Monte Carlo simulation results in "ection *.0
D. A Comparison o# A+DL and Phillips1Hansen Procedures
Here 2e #ocus on the case 2here there e.ists a uniEue cointegrating relation be1
t2een 3/(0 variables, y
t
and .
t
, possibly 2ith a deterministic trend. The case
2here there are multiple cointegrating relations among 3/(0 variables presents
ad1 ditional di5culties and 2ill not be discussed in this paper. /"ee Pesaran and
"hin /())*0, and the re#erences cited therein0.
Consider the #ollo2ing cointegrating relation
y
t
G [ I Rt I S
7
.
t
I v
t
F /D.(0
5.
t
G e
t
' /D.80
Although the 4L" estimator o# S is sho2n to be T 1consistent, /see "toc? /()B-00,
it has also been #ound that the 6nite sample behavior o# the 4L" estimator is
generally very poor /see, #or e.ample, =aner>ee et. al. /()BA00. specially, in the
presence o# non1Nero correlation bet2een v
t
and e
t
, 4L" estimators o# S in /D.(0
are o#ten heavily biased in 6nite samples, and in#erences based on them are invalid
because o# the dependence o# the limiting distribution o# the 4L" estimators on
nuisance parameters. %or details see Phillips and Loretan /())(0.
=roadly spea?ing, there are t2o basic approaches to cointegration analysis' ,o1
hansenZs /())(0 ma.imum li?elihood approach, and Phillips1HansenZs /())7, PH0
#ully modi6ed 4L" procedure.
(8
The A+DL approach to cointegration analysis
advanced in this paper is directly comparable to the PH procedure, and 2e shall,
there#ore concentrate on this method. PH assume that v
t
and e
t
in /D.(0 and /D.80
#ollo2 the general correlated linear stationary processes'
(9
v
t
G A
(
/L0u
t
F e
t
G A
8
/L0M
t
F /D.90
((
%or a computer implementation o# the A+DL approach using the 51method see
Pesaran and Pesaran /())-0.
(8
There are also other related procedures such as the original t2o1step method o# ngle and
@ranger /()B-0, the leads and lags estimation procedure suggested by "ai??onnen /())(0 and
"toc? and ;atson /())90, and the canonical method by Par? /())80.
(9
%or more details see Phillips and "olo /())80.
P(-Q
t
iG(
t
MM
t
(*
MM
2here p
t
G /u
t
F M
7
0
7
are serially uncorrelated random variables 2ith Nero means
and a constant variance matri. given by /9.(A0. Assuming A
(
/L0 and A
8
/L0 are
invertible, /D.(0 can be appro.imated as an A+DL speci6cation by truncating
the order o# the in6nite order lag polynomials PA
(
/L0Q
C(
and PA
8
/L0Q
C(
such that
K/L0 U PA
(
/L0Q
C(
and P/L0 U PA
8
/L0Q
C(
, 2here the orders o# the lag polyno1
mials K/L0 and P/L0 are denoted by p and s, respectively. Then 2e obtain the
appro.imate 6nite1dimensional A+DL/pF m0 speci6cation,
K/L0y
t
G #K/(0[ I RK
7
/(0g I RK/(0t I K/L0S
7
.
t
I q
uM
q
C(
P/L05.
t
I V F
/D.D0
MM t
2here K
7
/(0 G C
P
p
iK
i
, m G ma./pF s I (0, and by construction .
t
/and 5.
t
Zs0
are uncorrelated 2ith V
t
.
(D
<otice that /D.D0 is o# the same #orm as /9.()0, 2ith
the #ollo2ing relations among their parameters' H
7
G K/(0[ I RK
7
/(0, H
(
G RK/(0,
L G K/(0S, U
7
/L0 G K

/L0S
7
I q
uM
q
C(
P/L0, 2here K

/L0 is de6ned by K/L0

G
K/(0 I /( C L0K

/L0. There#ore, the A+DL speci6cation /D.D0 and the static

cointegrating #ormulation, /D.(0 and /D.80, represent alternative 2ays o# modelling
the serial correlation in v
t
Zs and the endogeneity o# .
t
.
Here 2e e.amine the PH estimation procedure in the conte.t o# the A+DL
appro.imation #or the y
t
process given by /D.D0. Assuming that \
t
G /v
t
F e
7
0
7
in /D.(0 and /D.80 satis#y the multivariate invariance principle, the long1run
variance matri. o# \
t
is given by
(*
/
T r
M
T T
i0
\
G Plim
T
C(
J
\
t
\
7
I T
C(
J
J
\ \
7
I
J
\ \
7
F /D.*0
T m(
t
tG( > G( tG>I(
t tC>
tG>I(
tC> t
2here the lag truncation parameter r increases 2ith T , such that rGT m 7, as
T m (. ;e also de6ne
/
T r T
0
5
\
G Plim T
C(
J
\
t
\
7
I
JJ
\ \
7
F /D.A0
T m(
tG(
t
>G( tG>I(
t tC>
and partition
\
and 5
\
con#ormably to \
t
G /v
t
F e
7
0
7
,
`
m
vv ve
W `
5
vv
5
ve
W
\
G
ev ee
F 5
\
G
5
ev
'
5
ee
Although the use o# the consistent estimator o# the long1run variance matri. may
solve the serial correlation problem o# v
t
, this does not address the
endogeneity
(D
As be#ore, V
t
G u
t
C q
uM
q
C(
M
t
'
The random seEuence s\
t
g is said to satis#y the multivariate invariance principle i# it is
strictly stationary and ergodic 2ith Nero mean, 6nite variances, and spectral density matri.
#
\\
/m0 T 7' "ee Phillips and Durlau# /()BA0 #or details.
P(BQ
t
t
(
t
ev ee
T
S
T
T
T
V
D *
(
problem. To deal 2ith the cross1correlations bet2een v
t
and current and lagged
values o# e
t
, PH consider the modi6ed error process, denoted by v
I
, 2hich
is
obtained #rom the regression o# v
t
on e
t
,
v
I C(
and v
I
t
G v
t
C
ve
ee
e
t
F /D.-0
is not correlated 2ith e
t
by construction. Then, the long1run variance
matri. o# \
I
G /v
I
F e
7
0
7
, denoted by
I
, is bloc? diagonalF that is,
I
G
t t t \ \
diag/m
v5e
F
ee
0, 2here
ee
F /D.B0
m
v5e
G m
vv
C
ve
C
ev
is the conditional long1run variance o# v
t
given e
t
. Combining /D.-0 2ith /D.(0
2e have the modi6ed XstaticY cointegrating relation,
y
I 7 I
t
G [ I Rt I S .
t
I v
t
F /D.)0
2here y
I
G y
t
C
ve
C(
5.
t
. There is still a bias term remaining in /D.)0 because
t ee
o# the correlation bet2een .
t
and current and lagged values o# v
I
, 2hich is given
by 5
I
G 5
ev
C 5
ee
C(
ev
. +emoving this bias leads to the Phillips1Hansen
#ully1modi6ed 4L" estimators,
8
[e
I
9
B 8
7
9)
G
A
e
I
-
(
a
I I
R
T
G /c
7
c
T
0
C
e
I
T
c
7
ye
T
C
D
7
'
d
?
*
T
5
e
F
ev
F /D.(70
2here c
T
G /d
T
F t
T
F J
T
0, d
?
is the ?1dimensional column unit vector, and ye
I
and 5
e
I
are consistent estimators o# y
I
and 5
I
, respectively.
ev t ev
"ince the asymptotic distribution o# the PH estimators o# the coe5cients on t
9
and .
t
/standardiNed by T
8
and T , respectively0 is /mi.ture0 normal, 2e have
g
8 C(
e
I
a
2here
W
e
I
"
_
T
D
"
T
/W
T
C W0 \ < #7F m
v5e
3
?I(
g F /D.((0
G /
e
R
I
F S
e
I7
0
7
. This is directly comparable to the asymptotic result
in
T T T
/9.870 obtained using the A+DL estimation procedure. %irst, 2e 6nd that the
estimators o# the long run parameters obtained using both the A+DL and the
PH estimation procedures have the mi.ture normal distributions asymptotically,
and standard in#erences on S using the ;ald test are there#ore asymptotically
valid. The main dierence bet2een the A+DL1based estimators and the #ully1
modi6ed 4L" estimators lies in the computation o# the long1run variance o#
the disturbances in the cointegrating regression. 3n the case o# the A+DL
estimation procedure the long run variance is given by ^
8
GPK/(0Q
8
, 2hile in the
case o# the PH estimation procedure the long run variance is given by m
v5e
. =ut
as Theorem
B belo2 sho2s, ^
8
GPK/(0Q
8
and m
v e
are identical #or the A+DL speci6cation
/9.()0
V
5
/or /D.D00.
P()Q
t
t
Theorem D.(. 3n the conte.t o# the A+DL speci6cation /9.()0 or /D.D0, the long1
run variance o# the Phillips1Hansen modi6ed error process, v
I
in /D.)0 /denoted
8 8
by m
v5e
0 is eEual to ^
V
GPK/(0Q , 2hich is the spectral density at Nero #reEuency o#
PK/L0Q
C(
V in /9.()0.
*. %inite "ample "imulation +esults
3n this section, using Monte Carlo techniEues, 2e compare 6nite sample properties
o# the Phillips1Hansen #ully1modi6ed estimators o# the long1run parameters 2ith
the A+DL1based estimators. 3n the case o# the A+DL procedure 2e consider
t2o dierent estimators o# the variance o# the long1run parameter, namely
the asymptotic #ormula /8.()0, 2hich is valid only #or 3/(0 regressors, and the
51 method #ormula given by /8.870, 2hich is valid more generally, irrespective
o# 2hether the regressors are 3/(0 or 3/70. ;e also include the 4L" estimators o#
the long1run parameters in the static cointegrating relation as a rather crude
bench mar? o# interest.
;e consider the #ollo2ing data generating process /D@P0, 2here the observa1
tions on y
t
and .
t
are generated according to the 6nite1order A+DL /(,70 model'
y
t
G H I Ky
tC(
I L.
t
I u
t
F /*.(0
.
t
C k.
tC(
G f /.
t
C k.
tC(
0 I M
t
F /*.80
t G (F '''F T F 2here /u
t
F M
t
0 are serially uncorrelated and are generated according
to the #ollo2ing bivariate normal distribution'
S
u
t
M
t
b f
\ < 7F G
S
( m
(8
m
(8
(
b^
' /*.90
;e set H G 7F L G (F f G 7'8F and e.periment 2ith the #ollo2ing parameter
values' K G /7'8F 7'B0, m
(8
G /C7'*F 7'7F 7'*0, and T G /*7F (77F 8*70.
;e carry out t2o sets o# e.periments' 3n the 6rst set /.periments (0 2e 6. k
at ( and there#ore, generate .
t
as an 3/(0 process. 3n the second set /.periments
80 2e set k to 7.)* such that .
t
is 3/70 but 2ith a high degree o# persistence. 3t is
2orth noting that in general /irrespective o# 2hether .
t
is 3/(0 or 3/700, the long
run parameter on .
t
in /*.(0 is given by
L I /( C k0m
(8
S G F
( C
K
and S 2ill be invariant to the parameters o# the .
t
process only i# m
(8
G 7 /i.e.,
.
t
is strictly e.ogenous in /*.(00 andnor 2hen k G ( /i.e., .
t
is 3/(00. %or a more
general treatment o# this issue see Pesaran /())-0.
P87Q
iG(
+
=e#ore discussing the simulation results, notice that 2hen m
(8
G 7, the correct
speci6cation is the A+DL/(,70 model, and 2hen m
(8
G 7F it is the A+DL/(,80
model. /"ee "ection 90. =ut since in general the true order o# the A+DL model is
not ?no2n a priori, 2e estimated 97 dierent A+DL models, namely A+DL/pF m0,
p G (F 8F '''F *, m G 7F (F 8F '''F *, and used the A?ai?e 3n#ormation Criterion
/A3C0, and the "ch2arN Criterion /"C0 to select the orders o# the A+DL model
be#ore estimating the long1run coe5cients and carrying out in#erences. The
estimates obtained by these t2o1step procedures 2ill be re#erred to as A+DL1
A3C, and A+DL1"C, respectively.
The simulation results are summariNed in Tables (a1(# and 8a18# #or .peri1
ments ( and 8, respectively. "ummary statistics included in these tables are'
=ias G
e
S
+
C S
7
, 2here S
7
is the true value o# the long1run coe5cient S,
e
S
+
is
the
mean o# the estimates o# S across replications, i.e.,
e
S
+
G
P
+
e
S
i
G+ and +
is the number o# replications,
"TD S G "tandard error o# the estimator,
i
, across replications,
S
E
b
+M" G The root mean sEuared error o#
e
S
i
,
C(
P
+
iG(
/
e
S
i
C S
7
0
8
F
Mean t G Average t1statistic #or testing S G S
7
against S G S
7
,
"TD t G "tandard deviations o# the t1statistic #or testing S G S
7
against S G
S
7
, "3c G mpirical siNe o# the t1test o# the null hypothesis S G S
7
against S
G S
7
, P4;+
I
G mpirical po2er o# the t1test under the alternatives S G
('7*S
7
, P4;+
C
G mpirical po2er o# the t1test under the alternatives S G
7')*S
7
.
The nominal siNe o# the tests is set at * percent, and the number o# replications
at + G 8F *77.
(A
Tables (a1(# summariNe the results #or the correctly speci6ed A+DL model
/namely the A+DL/(,70 2hen m
(8
G 7, and the A+DL/(,80 #or m
(8
G 70, the
estimates based on A+DL1A3C and the A+DL1"C procedures, and the Phillips1
Hansen #ully modi6ed estimators based on the =artlettZs 2indo2 #or 2indo2
siNes
7, *, (7, 87 and D7, 2hich are reported under PH/70, PH/*0, etc.
3n the case 2here m
(8
G 7, the bias o# the A+DL estimators is much smaller
than that o# the PH estimators. The e.tent o# the bias crucially depends on the
value o# K, and not surprisingly increases as K is increased #rom 7.8 in Table (a
(A
3n a very small number o# replications K/(0 2as estimated to be in e.cess o# 7.)). These
cases are not included in the summary results.
P8(Q
to 7.B in Table (d. Also the +M"Zs o# the A+DL and the PH estimators are
very similar 2hen K G 7'8, but diverge considerably #or K G 7'B. As can be seen
#rom Table (d, #or T G *7, the +M" o# the A+DL estimators is about one1third
o# the +M" o# the PH estimators. The empirical siNes o# the A+DL procedure
are much more satis#actory than the ones obtained using the PH #ully modi6ed
estimators. ;hen m
(8
G 7, the siNes o# the tests based on the A+DL estimators
are generally reasonable and much nearer to their nominal siNe o# * percent, than
the siNes o# tests based on the PH estimators.
mpirical siNes o# the tests based on the A+DL estimators computed using the
51method tend to be much closer to their nominal values, than those
computed using the asymptotic #ormula. This is particularly so 2hen T is small.
There#ore, in 2hat #ollo2s, 2e shall #ocus on the A+DL test statistics that are
computed using the 51method.
Another general #eature o# the simulation results is the slight superiority o# the
A+DL1"C method over the A+DL1A3C procedureF 2hich is in accordance
2ith the #act that the "C is a consistent model selection criterion, 2hile the
A3C is not. /"ee, #or e.ample, Ltt?epohl /())(, Chapter D00.
%inally, there is a clear tendency #or the tests based on the PH method to
over1re>ect in small samples, and the e.tent o# this over1re>ection increases 2ith
K, and declines only slo2ly 2ith the sample siNe, T . %or e.ample, #or K G 7'B
and T G (77, the empirical siNes o# the t1tests based on the PH method e.ceed
D( percent #or all the 6ve 2indo2 siNes, and even #or T G 8*7 do not #all belo2
87 percent. /"ee the column headed X"3cY in Table (d0. =y contrast the siNe o#
the test based on the 51method in Table (d is reasonable even #or T G *7. %or
the correct A+DL/(,70 speci6cation, the siNe o# the test based on the 51method
is -.8 percent and increases to (8.B and B.A percents #or the A+DL1A3C and the
A+DL1"C procedures, respectively.
"imilar results are obtained in the case 2here m
(8
G 7'*, and hence .
t
and u
t
are contemporaneously correlated. The A+DL estimators are no2 substantially
less biased than the PH estimators. /"ee the column headed X=3A"Y in Table
(e0. 4nce again the per#ormance o# the PH estimators improves 2ith the sample
siNe, but very slo2ly. %or T G 8*7, the bias o# the PH estimators #or the most
#avorable 2indo2 siNe is still around 17.(D, but the biases o# the A+DL estimators
lie bet2een 17.77(- and 7.778D. The siNe per#ormance o# the t2o test procedures
also closely mirrors these dierences in the degree o# biases o# the estimators.
The empirical siNe o# the tests based on the PH method ranges bet2een A7 to B*
percent #or T G *7, and #alls to around 8( percent #or T G 8*7 and a 2indo2 siNe
o# 87. The siNe o# the tests based on the A+DL procedure, 2hen the 51method
is used to compute the variances, is at most (9 percent #or T G *7, and lies in the
range *.8 to -.- percent 2hen T is increased to 8*7. /"ee Table (e0.
P88Q
Due to the large siNe distortions o# the PH procedure, the results presented
in Tables (a1(# do not allo2 proper comparisons o# the po2er properties o# the
t2o test procedures. =ut #or T G 8*7 2here the siNe distortion o# the PH test is
not too e.cessive, the A+DL procedure consistently outper#orms the PH method.
%or e.ample, in the case o# K G 7'B, m
(8
G 7'*F S G *, and T G 8*7, the po2er
o# the A+DL procedure in re>ecting the #alse null hypothesis, S G 7')*S
7
, is
consistently above )B percent 2hile the po2er o# the PH method is at most A8
percent even though its associated siNe is B* percentm There seems also to be a
tendency #or the po2er #unction o# the A+DL procedure in the case 2here m
(8
G 7 and T small to be asymmetric around S G S
7
F sho2ing a higher po2er #or
the alternatives e.ceeding S
7
as compared to the alternatives #alling belo2 S
7
.
The results #or .periments 8 2ith an 3/70 regressor are summariNed in Tables
8a18#. These results are very similar to those obtained #or .periments (. The
overall per#ormances o# the A+DL1based methods 2ith variances estimated using
the 51method are satis#actory #or most cases, though slightly 2orse than those
obtained #or .periments (. /3n particular, the biases are slightly larger and the
tests are less po2er#ul.0 =ut, the per#ormance o# the PH estimators are still very
poor, especially 2hen T is small.
4verall, the simulation results sho2 that the A+DL1based estimation proce1
dure based on the 51method developed in the paper can be reliably used in small
samples to estimate and test hypotheses on the long1run coe5cients in both cases
2here the underlying regressors are 3/(0 or 3/70. This is an important 6nding since
the A+DL approach can avoid the pretesting problem implicitly involved in the
cointegration analysis o# the long1run relationships. /Also see Cavanaugh et. al.
/())*0 and Pesaran /())-0.0
=e#ore concluding this section, 2e note that the comparison o# the small sam1
ple per#ormance o# the A+DL1based and the PH estimators is not comprehensive
in the sense that the data generating process 2e have used is biased in #avor o# the
A+DL procedure /see 3nder /())900. 3n this regard, it is more appropriate to con1
sider the relative per#ormances o# the A+DL and the PH estimators using more
general D@PZs, such as /D.(0 and /D.80, that can allo2 #or moving average error
processes. 3n the 2or?ing paper version o# this paper 2e also considered Monte
Carlo e.periments using /D.(0 and /D.80 as data generating processes. 3n one set o#
e.periments /called D@P 80 2e used 6rst1order bivariate vector moving1average
processes to generate the errors, v
t
and e
t
, and in another set o# e.periments
/called D@P 90 2e generated v
t
and e
t
according to 6rst1order vector autoregres1
sive processes. <either o# these D@PZs allo2s trans#ormations o# the model so
that .
t
could become strictly e.ogenous 2ith respect to the disturbances o# the
augmented A+DL model. ;e #ound that the simulation results based on these
D@PZs are less clear1cut, but the A+DL1based estimator using the 51method
P89Q
still outper#orms the PH estimator in most e.periments, especially #or small T
. =roadly spea?ing, the relative small sample per#ormance o# the t2o
estimators seems to depend on the signal1to1noise ratio, & ar/e
t
0G& ar/v
t
0, 2ith
the A+DL approach dominating the PH method 2hen this ratio is lo2, and vice
versa. This is clearly an area #or #urther research.
(-
A. Concluding +emar?s
The theoretical analysis and the Monte Carlo results presented in this paper pro1
vide strong evidence in #avor o# a rehabilitation o# the traditional A+DL approach
to time series econometric modelling. The #ocus o# this paper, ho2ever, has been
e.clusively on single eEuation estimation techniEues and the important issue o#
system estimation is not addressed here. "uch an analysis inevitably involves
the problem o# identi6cation o# short1run and long1run relations and demands a
structural approach to the analysis o# econometric models. The problem o#
long1run structural modelling in the conte.t o# an unrestricted &A+ model has
been addressed else2here. /"ee, #or e.ample, ,ohansen /())(0, Phillips /())(0
and Pesaran and "hin /())*00. An alternative procedure, 2hich ta?es us bac? to
the Co2les Commission approach, 2ould be to e.tend the A+DL methodology
advanced in this paper to systems o# eEuations sub>ect to short1run andnor long1
run identi#ying restrictions. /"ee, #or e.ample, =os2i>? /())*0 and Hsiao /())*0.0
;e hope to pursue this line o# research in the #utureF thus establishing a
closer lin? bet2een the recent cointegration analysis and the traditional
simultaneous eEuations econometric methodology.
(-
;e are grate#ul to Peter =os2i>? and an anonymous re#eree #or dra2ing our attention to
this point.
P8DQ
c
T
7
P
7
c
T
P
7
c
T
c
E
T
u
T
T
(
T
T
T
g g
;
T
@
(
T T
u @
Appendi.' Mathematical Proo#s
p a
%or notational convenience 2e use XmY, X0Y and X\Y to signi#y the convergence
in probability, the 2ea? convergence in probability measure, and the asymptotic
eEuality in distribution. All sums are over t G (F 8F '''F T .
3n the case 2here the regressors are stationary the usual method o# deriving
the asymptotic distribution o# the 4L" estimators o# the short1run parameters in,
#or e.ample, /8.(0, 2ould be to apply the "luts?yZs theorem to /P
7
P
c
T
0
C(
and
P
c
T
u
T
, separately, 2here P
c
T
G /d
T
F t
T
F J
T
F y
T C(
0F a#ter appropriately scaling
it by the sample siNe. /The appropriate scaling o#
c
T
P
c
T
in this case is given
( 9
( C(
by D
P
T
P
c
T
P
7
D
P
T
2here D
P
T
G Diag/T
C
8
F T
C
8
F T
C
3
?
F T
0'0 This procedure
cannot, ho2ever, be applied to dynamic time series models 2ith trended regres1
sors /irrespective o# 2hether the trends are stochastic or deterministic0, because
c
T
P
c
T
does not converge to a non1singular matri. even i# the individual elements
o# P
7
P
c
T
are appropriately scaled by the sample siNe.
3n 2hat #ollo2s the asymptotic theory 2ill be developed using the partitioned
regression techniEues and then 2riting individual elements o# the 4L" estimators
o# the short1run parameters as ratios o# random variables, thus avoiding the need
to apply the "luts?yZs theorem to /P
7
T
P
c
T
0
C(
directly.
"ince Theorems 8.( 1 8.D are special cases o# Theorems 9.( and 9.8, and can
be proved in a similar manner, 2e omit their proo#s to save space.
Proo# o# Theorem 9.(.
=e#ore deriving the asymptotic distributions o# the 4L" estimators o# the short
run parameters in /9.)0 2e derive some preliminary results. De6ne
(
E
:T uT
G T
C
8
:
7
u
T
F
g
G T
C(
:
7
:
T
F
T :
T
T
E G D
@
T
@
7
u
T
G
`
D
c
T
c
7
u
T
T
C
8
;
7
W ` W
G
c
T
u
T
F
E
;
T
u
T
E
T :T
G D
@T
@
7
:
T
G
`
D
c
T
c
7
:
T
(
T
C
8
;
7
W `
E
G
W
c
T
:
T
F
T
:
T
E
;
T
:
T
`
D
c
T
c
T
D
c
T
T
8
D
c
T
c
T
;
T
W ` W
c
T
c
T
;
T
g
@
G D
@
T
@
7
@
T
D
@
G
T
c
7 C 7
G F
T
T T
(
T
C 7
C( 7
g
7
8
;
T
c
T
D
c
T
T ;
T
;
T
g
c
T
;
T
T
2here :
T
G /`
(T
F `
8T
F '''F `
pT
0 2ith `
iT
G /`
i(
F `
i8
F '''F `
iT
0
7
#or i G (F '''F pF D
@
T
G
( 9 ( ( 9
Diag/T
C
8
F T
C
8
F T
C(
3
?
F T
C
8
3
?E
0 and
D
c
G Diag/T
C
8
F T
C
8
F T
C(
3
?
0' $sing the
results in Phillips and Durlau# /()BA0, it is easily seen that as T m (,
E
:
T
u
T
p
m E
:u
F
g
:
T
p
m g
:
F /A.(0
PA.(Q
(
+
(
e
+
(
'
u
@
T T
@
( (
8
(
9
*
T
T T
0 E G
`
E
cu
W
F E
E
;u
T
T
0
E
G
`
E
c:
E
;:
W
F /A.80
E
@ u @u
@ : @:
g
T
0 g
@
G
`
g
c
7
7 g
;
W
F /A.90
2here E
:u
, E
;u
, E
;:
, g
:
and g
;
are /6nite0 probability limits o# E
:
T
u
T
, E
;
T
u
T
,
E
;
T
:
T
, g
:
T
and g
;
T
, respectively, and E
cu
, E
c:
and g
c
are #unctionals o#
=ro2nian motions given by
8
E
cu
G
D
=
u
/(0
+
u
9 8
* c: D
=
:
/(0
9
+
: *
7
rd=
+
(
=
7
/r0 F E G
7
rd=
+
(
7
/r0 F
7
e
/r0d=
u
/r0
7
=
e
/r0d=
:
/r0
8 7
=
e
/r0dr
g
c
G
A
D
+
(
(
8
e
/r0dr
(
9
+
(
r=
7
/r0dr
+
7
r=
e
/r0dr
-
(
=
7
/r0= /r0dr
7
=
7
7
e
7
e
=
u
/r0 is the scalar =ro2nian motion process 2ith variance eEual to r times ^
8
/since u
t
is not serially correlated0, =
e
/r0 is a ?1dimensional =ro2nian motion on
r 8 P7F (Q 2ith variance eEual to r times the long1run variance o# e
t
F and =
:
/r0 is the p1dimensional =ro2nian motion on P7,(Q 2ith variance eEual to r times
the long run variance o# /`
(T
F `
8T
F '''F `
pT
0. The long1run variance o# a
stochastic process is given by 8U multiplied by the spectral density o# the
process at Nero #reEuency. <otice that g
c
/or g
@
0 is o# the #ull column ran? by
assumption /AD0, and the elements in g
c
involving =
e
/r0 are random even
asymptotically.
"ince `
(T
F `
8T
F '''F `
pT
F and (F tF .
t
F 5.
t
F 5.
tC(
F '''F 5.
tCEI(
are all distrib1
uted independently o# u
t
such that =
:
/r0 and =
e
/r0 are independent o# =
u
/r0, it
#ollo2s that
a
8
a
8
E
:u
\ <
C
7F ^
u
g
`
5
F E
@u
\ M<
C
7F ^
u
g
@
5
F /A.D0
2here M< denotes the mi.ture normal distribution. %or details concerning
the theory o# the mi.ture normal distribution see, #or e.ample, Phillips /())(0.
Ho21 ever, this /mi.ture0 normality result does not hold in the case o# E
@:
,
because .
t
and 5.
tCi
Zs /i G 7F '''F E C (0 are correlated 2ith `
it
, i G (F '''F p.
The 4L" estimators o# # and K in /9.)0, denoted by
e
#
T
and K
e
T
, satis#y
the
relations,
K
e
T
C K G /!
7
M
@
!
T
0
C(
/!
7
M
@
u
T
0 F /A.*0
T T T T
Vi
e
#
T
C # G /@
7
@
T
0
C(
h
u
T
C
@
!
T
p
K
e
C K F /A.A0 7 7
T T T T
2here M
@
G 3
T
C @
T
/@
7
@
T
0
C(
@
7
!
T
can be e.pressed as
2ith 3
T
being the T O T identity matri..
$sing /9.-0,
!
T
G @
T
C I :
T
F /A.-0
PA.8Q
S S 5 5 5 S
g
(
g
8
5 5 5 g
p
7 7 7
7 7 7
7 7 7
A
F
i7
F g
iFE (
(
#
T
@
T
(
g
;
7
D
i(
K K
T
(
*
2here
8
[
(
[
8
5 5 5 [
p
9
C G
A
D
R R 5 5 5 R
-
-
*
and g
i
G /g
7 7
F '''F g
7
C
0
7
is a ?E O ( vector o# parameters. $sing /A.-0 2e have
!
7 7 7 7
C(
7
T
M
@
T
!
T
G :
T
:
T
C :
T
@
T
/@
T
@
T
0
@
T
:
T
F
!
7 7 7 7
(
7
T
M
@
T
u
T
G :
T
u
T
C :
T
@
T
/@
T
@
T
0
C
@
T
u
T
F
2here 2e used @
7
M
@
G 7' $sing /A.(0 1 /A.90, it can be sho2n that as T m
(,
T T
T
C(
/!
7
p
T
M
@
T
!
T
0 G g
:
T
I o
p
/(0 m g
:
F /A.B0
(
p
T
C
8
/!
7
M
@
u
T
0 G E
: u
I o
p
/(0 m E
:u
' /A.)0
T T T T
Multiplying /A.*0 by
p
T , and using /A.B0, /A.)0 and /A.D0, 2e obtain /9.(70.
<e.t, substituting !
T
#rom /A.-0 in /A.A0, 2e obtain
e
#
T
C # G /@
7
@
T
0
C(
@
7
u
T
C C
p
e
C
V
C /@
7
@
T
0
C
@
7
:
T
p
K
e
C
V
' /A.(70
T
De6ne
T
K
T T T T
V
d
T
G
p
e
C #
V
I C
p
K
e
C K
' /A.((0
Multiplying /A.((0 by D
C(
, using /A.(0 1 /A.90 and /A.(70, and applying the
T
continuous mapping theorem /see, #or e.ample, Phillips and Durlau# /()BA00, it
#ollo2s that
D
C( C( C(
@
T
d
T
G g
@
T
E
@
T
u
T
I o
p
/(0 0 g
@
E
@u
' /A.(80
"ince E
@u
is sho2n to be mi.ture normal in /A.D0, hence
g
C(
a
8 C(
8
C(
a
8
@
E
@u
\ M<
C
7F ^
u
g
@
5
F g
@
D
@
T
d
T
\ <
C
7F ^
u
3
?I?EI8
5
'
<e.t, pre1multiplying /A.(80 by the diagonal matri., Diag/(F T
C(
F T
C
8
3
?
F 3
?E
0, 2e have
8
( 7 7 7
9
p A
7 T
C(
7 7
-
T d
T
G
A
(
-
g
C(
E
@ u
I o
p
/(0 /A.(90
D
7 7 T
C
8
3
?
7
*
@
T
T T
7 7 7 3
?E
8
( 7 7 7
A
7 7 7 7
0
9
-
g
C(
a
B 8
((
c
a
T
A
7
9)
-
T
G
F A
7 7 7 7
-
7 7 7 3
?E
@
E
@u
\ M<
7F
A
D
'
T
7 7 7 g
C(
-
*
T
F
PA.9Q
T
p
L

c
uT
/P
T
T
T
e
T
@
T
K
(8
2here g
((
is the /(,(0 element o# g
C(
. The above result can be re2ritten sepa1
c c
rately #or He
7T
F ec
T
and L
e

as
p
C 5
p
p
e
V
T /He
7T
C
H
7
0 I
p
[
(
F [
8
F '''F [
p
T K
T
C
K
p
G d
cuF(
I o
p
/(0F /A.(D0
V
T /ec
T
C c0 I
Wd
7
T
p
K
e
C K G o
p
/(0F /A.(*0
p

T
p
e
V
p
p
e
V
T
C
L

I /g
(
F g
8
F '''F
g
p
0
T K
T
C
K
G g
C(
E
;u
I o
p
/(0F /A.(A0
;
2here d
p
is a p O ( vector o# unity and d
cuF(
is the 6rst element o# g
C(
E
cu
. $sing
/9.(70 in /A.(*0 2e obtain /9.((0. 3t is also clear #rom above results that the
4L" estimators o# H
7
and L

/standardiNed by
p
T 0 have the /mi.ture0
normal
distributions asymptotically.
%inally, using /9.(70, /9.((0, and /A.(901/A.(A0, it is easily seen that a consis1
tent estimator o# the variance o# h
e
T
is given by &
e
/h
e
T
0 G ^e
8
7
P
@
T
0
C(
2ith
the ran? o# &
e
/h
e
T
0 being eEual to ?E I 8.
Proo# o# Theorem 9.8.
Partition d
T
G /a
T
F s
7
F 2
7
0
7
con#ormably to @
T
G /d
T
F "
T
F ;
T
0F then s
T
is
given by
T
s
T
G
p
T
/ec
T
C c0 I Wd
7
p

p
K
e
C
V
' /A.(-0
T
p
T
T
$sing /A.(70 and /A.((0, /s
7
F 2
7
0
7
can be e.pressed as
T T
`
s
T
W `
"
7
G
7
W
(
`
T
W
/A.(B0
T
H
T
"
T
"
T
H
T
;
T
C
"
7
H
T
u
T
T
H
T
"
T
;
7
H
T
;
T
;
7
H
T
u
T
`
"
7 7
W
C(
` W
p V
T
H
T
"
T
"
T
H
T
;
T
"
7
H
T
:
T
K
e
K ' C
;
7 7 7 T
C
Let
T
H
T
"
T
;
T
H
T
;
T
;
T
H
T
:
T
E
"_
T
u
T
G D
"
T
"
T
H
T
u
T
F g
"_
T
G D
"
T
"
T
H
T
"
T
D
"
T
F
7 7
9
(
2here D
"
T
G Diag/T
C
8
F T
C
3
?
0. Then, it is also easily seen that as T m (,
M
+
(
(
i
E
"
_
T uT
0 E
"
_
u
G
7
/r C
8
0d=
u
/r0
+
(
=
_
7
F /A.()0
7
e
/r0d=
u
/r0
M
(
+
(
(
i
g
"
_T 0 g
"
_
G
+
( ( 7
7
/r C
8
0=
_
e
/r0dr
+
(
F /A.870
7
/r C
8
0=
_
e
/r0dr
7
=
_
7
/r0=
_
e
/r0dr
PA.DQ
D
"
7 C(
" "
_
"
t
C
t
C
t
C
(
(
T
2here =
_
e
/r0 G =
e
/r0 C
+
=
e
/r0dr is a ?1dimensional demeaned =ro2nian motion
7
on P7F (Q. "ince =
_
e
/r0 is also distributed independently o# =
u
/r0, 2e obtain as
in
/A.D0,
a
8
E
"
_
u
\ M<
C
7F ^
u
g
"
_
5
' /A.8(0
Multiplying /A.(B0 by the diagonal matri., Diag/D
C(
F T
(
0, using /A.()01/A.8(0
and noting that
"
T
8
T
" H
T
;
T
G 4
p
/(0F T ;
7
H
T
;
T
G 4
p
/(0F
T T
(
D
"T
"
7
H
T
:
T
G 4
p
/(0F T
C
8
;
7
H
T
:
T
G 4
p
/(0F
2e obtain
T
D
C( C(
a
T
p
8 C(
V
and there#ore,
"
T
s
T
0 g
_
E
"
_
u
\ M< 7F ^
u
g
_
F
g
8 C(
a
C
8
5
"
_
T
D
"
T
s
T
\ <
%inally, by /9.(90 and /A.(*0 2e have
7F ^
u
3
?I(
s
T
' /A.880
W
e
T
C W G
K
e
T
/(0
' /A.890
(
Multiplying /A.890 by g
8
"
T
D
C(
, using /A.880 and noting that
K
e
T
p
/(0 m K/(0F 2e
obtain /9.(D0.
Proo# o# Theorem 9.9 can be established in a similar manner and is omitted to
save space.
Proo# o# Theorem D.(.
Consider the dynamic A+DL/pF m0 model /9.()0 /or /D.D00, and its static coun1
terpart /D.(0. Applying the decomposition K/L0 G K/(0 I /( C L0K

/L0 to
/9.()0 2e have
H
7
U
7
/L0 V
t
K

/L0
y
t
G
K/(0
I Rt I S
7
.
t
I
5. I
K/(0 K/(0
5y
t
' /A.8D0
K/(0
"ubstituting #or 5y
t
G R I S
7
5.
t
I 5v
t
#rom /D.(0 in /A.8D0, 2e have
U
7
/L0 V
t
K

/L0
y
t
G [ I Rt I S
7
.
t
I
5. I
K/(0 K/(0
/S
7
5.
t
I 5v
t
0 ' /A.8*0
K/(0
$sing /A.8*0, v
t
in /D.(0 can be e.pressed as
U
7
/L0 C K

/L0S
7
V
t
K

/L0
v
t
G 5. I
K/(0 K/(0
5v
t
' /A.8A0
K/(0
PA.*Q
t
0 G
8
^
8
Vv
^
7
t
t
C

t
^
t
ee
^
v
V
De6ning ?
t
G /V F v
t
F 5.
7
0
7
G /V F v
t
F e
7
0
7
, and j/L
h
(
F
CK

/L0/(CL0
F
U
7
/L0CK

/L0S
7
i
,
t t t K/(0 K/(0 K/(0
then the spectral density o# v
t
G j/L0?
t
is given by
8U#
vv
/m0 G j/e
i2
0& ar/?
t
0j
7
/e
Ci2
0F
2here
V
^
Vv
7
9
& ar/?
t
0 G
D
^
7 8
q
ve
*
'
7 q
ve
q
ee
Hence, the spectral density o# v
t
at Nero #reEuency is given by
^
8 7
8U#
vv
/70 G
V
I PU /(0 C K

/(0S
7
Q q
ee
PU/(0 C K

/(0SQ
PK/(0Q
8
' /A.8-0
The Phillips1Hansen semi1parametric correction is eEuivalent to removing the
sec1 ond part o# /A.8-0, by subtracting the terms involving 5.
t
#rom v
t
. $sing
/A.8A0 2e have the #ollo2ing e.pression #or the modi6ed disturbance term,
v
I
, in the
Phillips1HansenZs procedure'
v
I
U
7
/L0 C K

/L0S
7
V
t
K

/L0
I I
t
G v
t
C 5. G
K/(0 K/(0
5v
t
G j
K/(0
/L0?
t
F
2here ?
I
G /V F v
t
0
7
F and j
I
/L0 G
h
(
F
CK /L0/(CL0
i
' There#ore, the spectral
t t
K/(0 K/(0
density o# v
I
at Nero #reEuency is given by
8
7
V
8U#
v
I
v
I /70 G j
I
/70& ar/?
I
0j
I
/70
G
PK/(0Q
8
'
$sing /D.-0 2e also have
#
v
I
v
I /70 G =#
\\
/70=
7
F
2here = G P(F C
ve
C(
Q. =y de6nition
\
G 8U#
\\
/70, and
8
8U#
v
I
v
I /70 G =
\
=
7
G m
vv
C
ve
C(
ev
G '
ee
PK/(0Q
8
8
8
Hence, by /D.B0 m
v5e
G ^
V
G PK/(0Q .
PA.AQ
+e#erences
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librium +elationships in conomics through "tatistical Models' "ome Monte
Carlo vidence,Y 4.#ord =ulletin o# conomics and "tatistics, DB' 8*918--.
P8Q =ardsen, @. /()B)0, XThe stimation o# Long1+un Coe5cients #rom rror
Correction Models,Y 4.#ord =ulletin o# conomics and "tatistics, *(' 9D*1
9*7.
P9Q =e2ley, +. /()-)0, XThe Direct stimation o# the Euilibrium +esponse in a
Linear Dynamic Model,Y conomics Letters, 9' 9*-19A(.
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"tructural rror Correction Models,Y ,ournal o# conometrics, A)' (991(*B.
P*Q Cavanaugh, C.L., @. lliott and ,.H. "toc? /())*0, X3n#erence in Models 2ith
<early 3ntegrated +egressors,Y conometric Theory, ((' ((9(1((D-.
PAQ ngle, +.%. and C.;.,. @ranger /()B-0, XCointegration and rror Correction
+epresentation' stimation and Testing,Y conometrica, **' 8*(18-A.
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3ntrili1 gator0, <orth Holland
PBQ Hsiao, C. /())*0, XCointegration and Dynamic "imultaneous Euations
Model,Y unpublished manuscript, $niversity o# "outhern Cali#ornia.
P)Q 3nder, =. /())90, Xstimating Long +un +elationships in conomics,Y ,our1
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P(7Q ,ohansen, ". /())(0, Xstimation and Hypothesis Testing o# Cointegrating
&ectors in @aussian &ector Autoregressive Models,Y conometrica, *)' (**(1
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P((Q Ltt?epohl H. /())(0, 3ntroduction to Multiple Time "eries Analysis, <e2
!or?, <.!. "pringer and &erlag.
P(8Q Par?, ,.!. /())80, XCanonical Cointegrating +egressions,Y conometrica, A7'
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P(9Q Pesaran, M.H. /())-0, XThe +ole o# conomic Theory in Modelling the Long1
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Analysis, 4.#ord $niversity Press /#orthcoming0.
P(*Q Pesaran, M.H. and !. "hin /())*0, XLong1+un "tructural Modelling,Y un1
published manuscript, $niversity o# Cambridge.
P(AQ Pesaran, M.H., !. "hin and +.,. "mith /())A0, XTesting #or the .istence o# a
Long1+un +elationship,Y DA ;or?ing Papers Amalgamated "eries, <o.
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