Keywords: Cointegration; nonlinearity; interest rates; nonparametric estimation
Abstract: We derive a definition of linear cointegration for nonlinear stochastic processes
using a martingale representation theorem. The result shows that stationary linear
cointegrations can exhibit nonlinear dynamics, in contrast with the normal assumption
of linearity. We propose a sequential nonparametric method to test first for
cointegration and second for nonlinear dynamics in the cointegrated system. We
apply this method to weekly US interest rates constructed using a multirate filter
rather than averaging. The Treasury Bill, Commerical Paper and Federal Funds rates
are cointegrated, with two cointegrating vectors. Both cointegrations behave nonlinearly.
Consequently, linear models will not fully replicate the dynamics of monetary policy transmission.
Full paper (411 KB PDF)
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Last update: July 25, 2007