CEE 4221 Study Guide - Quiz Guide: Time Series, Linear Combination, Arbitrage
Document Summary
But the disturbances would have some very undesirable properties: zt is not stationary and is autocorrelated if all of the xi are i(1). We want to ensure that the disturbances are i(0). Many time series are non-stationary but move together over time. If variables are cointegrated, it means that a linear combination of them will be stationary. There may be up to r linearly independent cointegrating relationships (where r k-1), also known as cointegrating vectors. r is also known as the cointegrating rank of zt. A cointegrating relationship may also be seen as a long term relationship. Examples of possible cointegrating relationships in finance: spot and futures prices ratio of relative prices and an exchange rate equity prices and dividends. Market forces arising from no arbitrage conditions should ensure an equilibrium relationship. No cointegration implies that series could wander apart without bound in the long run.