Myles S. Wallace

Cointegration and market efficiency

Abstract Recently, many economists have asserted that asset prices determined in efficient asset markets cannot be cointegrated. We show that there is no general equivalence between the existence of arbitrage opportunities and cointegration or, for that matter, a lack of cointegration. Whether asset prices are cointegrated is a function of the relevant model. We first show a convenient way to calculate the cointegrating vector based on necessary and sufficient conditions for cointegration. We then examine particular cases, including exchange rates, interest rates and spot and forward exchange rates, and asset prices with incoem flows reinvested and not reinvested. (JEL F31)

National price levels, purchasing power parity, and cointegration: a test of four high inflation economies

Abstract The time series properties of exchange rates and wholesale prices from four high inflation countries show some evidence in support of purchasing power parity. Tests for stationarity of real exchange rates and cointegration among price and exchange rate variables are presented for Argentina, Brazil, Chile, and Israel during the 1970s and 1980s. Error correction models describe the mechanism of adjustment to long-run equilibrium.

Misleading Inferences from Panel Unit-Root Tests with an Illustration from Purchasing Power Parity

Simulations demonstrate that when unit-root behavior is rejected in a Levin and Lin panel test, it is incorrect to infer that all series are stationary. Recent tests proposed by Im, Pesaran and Shin, and by Sarno and Taylor, are also incapable of determining the mix of I(0) and I(1) series in a panel setting. This paper introduces a new unit-root test that allows the researcher to discern which series are I(0) and which ones are I(1). The test has double to triple the power of single-equation augmented Dickey-Fuller tests. Copyright 2001 by Blackwell Publishing Ltd.

Government Spending and Taxation: What Causes What?

In the past few years, as federal deficits have risen to high nominal levels, economists have argued about the effect that raising taxes, ostensibly to reduce deficits, might have on government spending. Some economists, including Milton Friedman, have argued that raising taxes will simply lead to more spending. Others, including James Buchanan and Richard Wagner, have said that the high deficits themselves have been responsible for the growth of federal spending and that if that spending had to be financed completely by direct taxes, people would demand that the federal government spend less. A third group, led by Robert Barro, says that increased taxes and borrowing are results of increased government spending. In section II we briefly review various hypotheses about the relationship between federal government spending and revenues. Section III describes the testing procedure used to discriminate between these hypotheses. The results of four tests are presented in section IV. Section V contains a summary and major conclusions. To foreshadow what follows, we find no evidence that higher real federal taxes today lead to either higher or lower federal spending tomorrow. On the other hand, we find strong evidence that higher spending now will lead to higher taxes later. Our results support a view of the world in which the political system somehow determines how much to spend and then looks for revenue sources to finance that level of spending, including direct taxation, borrowing, and money creation. We also find evidence that real federal revenues are positively affected by real Gross National Product (GNP). Real federal spending also rises with real GNP, but it appears to be independent of the rate of inflation.

Series-Specific Unit Root Tests with Panel Data

A unit root testing procedure is presented that exploits the well-established power advantages of panel estimation while rectifying a deficiency in other panel unit root tests. This test (called SURADF) is based on seemingly unrelated regressions applied to Augmented Dickey-Fuller (ADF) tests for a unit root. In contrast to extant panel unit root tests, our test allows for determination of which members of the panel reject the null hypothesis of a unit root and which ones do not. The power of the test is investigated with Monte Carlo simulation and demonstrated with application to several panels of real exchange rates. We find that when the contemporaneous cross-correlations of the residuals are high, our procedure has substantially more power to reject a unit root than the single equation Dickey-Fuller test. Copyright 2002 by Blackwell Publishing Ltd

Cointegration tests of a long-run relation between money demand and the effective exchange rate

Abstract For the period starting with the floating of the US dollar we find evidence that long-run stationarity of the demand function for M2 (but not M1) requires inclusion of the effective exchange rate. These results lend some support to McKinnons hypothesis that nonstationarity in the demand for money can be resolved by inclusion of the exchange rate. (JEL F41, E41).

The Fisher effect and the term structure of interest rates: Tests of cointegration

The literature on the Fisher effect has ignored the potential relationship between inflation and long-term interest rates. Using an expectations model of the term structure of interest rates, the authors establish the conditions under which innovations in short-term inflation will be transmitted to long-term as well as short-term interest rates. Cointegration tests find support for both the Fisher effect and the expectations theory of the term structure. Copyright 1993 by MIT Press.

Cointegration Tests of the Monetary Exchange Rate Model for Three High-Inflation Economies

Tests of cointegration are applied to the monetary model of the exchange rate to determine if the model represents a long-run equilibrium relation for three high-inflation countries. The countries tested are Argentina, Chile, and Israel, each paired with the United States as the base country. Evidence favorable to cointegration among the variables of the monetary model is found using Johansens maximum likelihood procedure. Copyright 1994 by Ohio State University Press.

Purchasing Power Parity and the Canadian Float in the 1950s

In this paper, the authors present evidence that neither large differences in inflation nor long time periods are necessary for a finding favorable to purchasing power parity. Evidence from cointegrating regressions and tests of the real exchange rate indicate that purchasing power parity held as a long-run constraint between the United States and Canada for the period 1950:10 to 1961:5. The authors also find that government intervention can distort purchasing power parity over a finite period. Once the data were extended beyond the period of the free float, the evidence is no longer favorable to purchasing power parity. Copyright 1991 by MIT Press.

Non-Informative Tests of the Unbiased Forward Exchange Rate

This paper reexamines a familiar but unsettling result in the foreign exchange literature: that the forward rate is not an unbiased predictor of the future spot rate. The paper outlines why some frequently used tests of unbiasedness are non-informative in the sense that they are incapable of correctly testing the hypothesis. Specifically, many of these tests are based on regressions that suffer from simultaneity bias, resulting in biased and inconsistent estimators. This is true whether the tests are conducted using stationary or non-stationary data. We demonstrate this point both analytically and with simulations. Tests of co-integration, which are not subject to the critique presented in the paper, generally fail to reject unbiasedness.