Articlegreen2003

Fractional cointegration and tests of present value models

Guglielmo Maria Caporale · Luis A. Gil-Alana

68 citations0/0 files storedReview of Financial Economics

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Financial Markets and Investment Strategies Financial Risk and Volatility Modeling Complex Systems and Time Series Analysis

Abstract

Abstract This paper tests the validity of present value (PV) models of stock prices by employing a two‐step strategy for testing the null hypothesis of no cointegration against alternatives which are fractionally cointegrated. Monte Carlo simulations are conducted to evaluate the power and size properties of this test, which is shown to outperform existing ones, and to compute appropriate critical values for finite samples. It is found that stock prices and dividends are both I(1) nonstationary series, but they are fractionally cointegrated. This implies that, although there exists a long‐run relationship, which is consistent with PV models, the equilibrium errors exhibit slow mean reversion. As the error correction term possesses long memory, deviations from equilibrium are highly persistent.

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References

1987Co-Integration and Error Correction: Representation, Estimation, and Testing 1979Distribution of the Estimators for Autoregressive Time Series with a Unit Root 1988Testing for a Unit Root in Time Series Regression 1991Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models 1979Distribution of the Estimators for Autoregressive Time Series With a Unit Root 1982Trends and random walks in macroeconmic time series 1980Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?1983THE ESTIMATION AND APPLICATION OF LONG MEMORY TIME SERIES MODELS

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