Structural analysis of vector error correction models with exogenous I(1) variables

This paper generalizes the existing cointegration analysis literature in tw o respects. Firstly, the problem of efficient estimation of vector error co rrection models containing exogenous I(l) variables is examined. The asympt otic distributions of the (log-)likelihood ratio statistics for testing coi ntegrating rank are derived under different intercept and trend specificati ons and their respective critical values are tabulated. Tests for the prese nce of an intercept or lineal. trend in the cointegrating relations are als o developed together with model misspecification tests. Secondly, efficient estimation of vector error correction models when the short-run dynamics m ay differ within and between equations is considered. A re-examination of t he purchasing power parity and the uncovered interest rate parity hypothese s is conducted using U.K. data under the maintained assumption of exogenous ly given foreign and oil prices. (C) 2000 Elsevier Science S.A. All rights reserved. JEL classification: C12; C13; C32.