Question

econometrics.

explain how to test for contegration for the two and describe the error correction model.

Answer 1

Cointegration is the long-run relationship between two or more variables. If both variable are non stationary then check the cointegration between them. It is the co-moment of variable overtime. There is a chance of cointegration if the linear combination of both variable leads to a a stationary time series.

Error correction term is derived from the long run equilibrium relationship if cointegration hold. It shows the short run dynamics and adjustment toword long run equilibrium relationship. It should be negative between 0 and -1. It should be a statistical significant. It supports the evidence of cointegration depict the convergence. Suppose the value of error correction term is 0.5 then it means that short run correction happen 50% per time period say per year for yearly data. Also called as 50% off error corrected every year or period.