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Econometrics Paper
Instrumental Variables Estimation of Stationary and Nonstationary Cointegrating Regressions
Peter M Robinson and M. Gerolimetto April 2006
Paper No' EM/2006/500:
Full Paper (pdf)

JEL Classification: C32

Tags: cointegration; instrumental variables estimation; i(d) processes.

Instrumental variables estimation is classically employed to avoid simultaneous equations bias in a stable environment. Here we use it to improve upon ordinary least squares estimation of cointegrating regressions between nonstationary and/or long memory stationary variables where the integration orders of regressor and disturbance sum to less than 1, as happens always for stationary regressors, and sometimes for mean-reverting nonstationary ones. Unlike in the classical situation, instruments can be correlated with disturbances and/or uncorrelated with regressors. The approach can also be used in traditional non-fractional cointegrating relations. Various choices of instrument are proposed. Finite sample performance is examined.