Fourier ADL cointegration test to approximate smooth breaks with new evidence from Crude Oil Market

Economic data is typically subject to a number of different forms of structural breaks. Ignoring structural breaks in a model can lead to misspecification issues and false conclusions. This paper proposes a new Autoregressive Distributive Lag (ADL) cointegration test in the presence of nonlinear bre...

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Bibliographic Details
Published inEconomic modelling Vol. 67; pp. 114 - 124
Main Authors Banerjee, Piyali, Arčabić, Vladimir, Lee, Hyejin
Format Journal Article
LanguageEnglish
Published Elsevier B.V 01.12.2017
Subjects
ADL
C12
C15
C22
C51
Cointegration
Fourier function
Oil prices
Structural breaks
Structural breaks
Oil prices
C22
C12
Cointegration
C15
ADL
Fourier function
C51
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Summary:Economic data is typically subject to a number of different forms of structural breaks. Ignoring structural breaks in a model can lead to misspecification issues and false conclusions. This paper proposes a new Autoregressive Distributive Lag (ADL) cointegration test in the presence of nonlinear breaks approximated by a Fourier function. The test offers a simple way to capture smooth structural change in time series data. Exact break dates are not required, and the suggested methodology can accommodate unknown number and form of gradual structural change. The testing procedure circumvents the potential power loss which can result from adding more dummy variables in the testing equation. Simulation results show that our procedure has good size and power properties. We demonstrate our test on the empirical example of real oil prices, oil production, and real economic activity, which are subject to structural breaks. The new test suggests that variables are cointegrated, while a conventional ADL test ignores structural breaks and concludes the opposite. This result casts some doubt on conventional oil price models. •We augment the existing ADL cointegration test with a flexible Fourier function.•The test can capture unknown structural breaks, and it is easy to implement.•We use it to test for cointegration on a crude oil market.•New test indicates that variables are cointegrated as opposed to the linear ADL.•Simulation results confirm good size and power properties of the test.
ISSN:0264-9993
1873-6122
DOI:10.1016/j.econmod.2016.11.004