Bayesian Estimation and Selection of Nonlinear Vector Error Correction Models: The Case of the Sugar‐Ethanol‐Oil Nexus in Brazil

Abstract

Abstract Nonlinear adjustment toward long‐run price equilibrium relationships in the sugar‐ethanol‐oil nexus in Brazil is examined. We develop generalized bivariate error correction models that allow for cointegration between sugar, ethanol, and oil prices, where dynamic adjustments are potentially nonlinear functions of the disequilibrium errors. A range of models are estimated using Bayesian Monte Carlo Markov Chain algorithms and compared using Bayesian model selection methods. The results suggest that the long‐run drivers of Brazilian sugar prices are oil prices and that there are nonlinearities in the adjustment processes of sugar and ethanol prices to oil price but linear adjustment between ethanol and sugar prices.

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