TOPIC 6:

STATIONARY AND
NONSTATIONARY
VARIABLES
By:
Assoc. Prof. Dr. Sallahuddin Hassan
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Applied Econometrics

DEFINITION OF
STATIONARY

A time series Yt is stationary if its

mean and variance are constant
over time, and if the covariance
between two values from the
series depends only on the length
of time seperating the two values,
and not the actual times at which
the variables are observed.
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DEFINITION OF
Stationary and non-stationary variables
STATIONARY
must be distinguished.

Stationary is important because if the

series is non-stationary then all types of
the typical results of the classical
regression analysis are not valid.
It is crucial for the properties of standard
estimation and testing procedures

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SPURIOUS REGRESSION

Regressions with non-stationary

series may have no meaning and are
therefore called spurious regression
(Granger & Newbold, 1974).
Because both Yt and Xt contain a
stochastic trend, the OLS estimator
tends to find a significant correlation
between the two series, even if they
are completely unrelated
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SPURIOUS REGRESSION

The results from this regression are

likely to be characterized by a
fairly high R2 statistic, highly
correlated residuals, a significant
value for and a low Durbin-Watson
(DW) statistics.
Therefore, the usual t and F
tests on the regression parameters
may be very misleading.
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UNIT ROOT TESTS

There are many tests for

determining whether a series is
stationary or nonstationary.
A unit root test can be tested using:

Dickey-Fuller (DF) test,

Augmented Dickey-Fuller (ADF) test,
Phillips-Perron test and
Kwiatkowski et al. test.
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Dickey Fuller Test

The Dickey-Fuller tests (DF tests)

developed by David Dickey (1976),
Wayne Fuller (1976), and David
Dickey and Wayne Fuller (1979,
1981) are the most popular tests

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Dickey Fuller Test

The DF test for unit root is actually
based on the AR(1) process:

Case 1: No constant and no trend

Random walk process:
Yt Yt 1 t
Case 2: With constant and no trend
Yt Yt 1 t

Case 3: With constant and with trend

Yt t Yt 1 t
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Dickey Fuller Test

Plot the time series of variable for selecting

the appropriate DF testing procedure.

If the series appears to be wandering or

fluctuating around a sample average of zero,
use Case 1.
If the series appears to be wandering of
fluctuating around a sample average which is
nonzero, use Case2.
If the series appears to be wandering of
fluctuating around a linear trend, use Case 3.

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Dickey Fuller Test

Hypothesis:

H0 : 1

H1 : 1

Non stationary
Stationary

Use tau ( ) statistics

Reject Ho if C

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Dickey Fuller Test

Critical Values for the Dickey-Fuller Tests

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AUGMENTED DF

The Augmented Dickey-Fuller

(ADF) (1979) regression tests for
Yt
the existence
of unit root
.
Yt 1
The variable
expresses the
first difference with k lag.
Extension of DF test allows for
possibility that the error term is
autocorrelated.
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AUGMENTED DF

The ADF test is referred to the t statistics

of coefficient on the following
regression:
Yt Yt 1

i 1

Yt i t

Yt Yt 1 i Yt i t
i 1

Yt t Yt 1 i Yt i t
i 1

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COINTEGRATION

The concept of cointegration was first

introduced by Granger (1981).
Elaborated further by:
Engle and Granger (1987)
Engle and Yoo (1987)
Phillips and Ouliaris (1990)
Stock and Watson (1988)
Phillips (1986, 1987)
Johansen (1988, 1991, 1995)
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COINTEGRATION
Engle and Granger (1987) defined
cointegration as a state that if two (or
more) series are linked to form an
equilibrium relationship spanning in
the long run.
Cointegration implies that two random
variables, let says Yt and Xt, share
similar stochastic trends in common.

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MATHEMATICAL APPROACH
OF COINTEGRATION

Y , X
Consider a set of two variables
that
are integrated of orderY ,1X (i.e.
)
~ I 1
and suppose that there
is a vector
1 , 2
which gives aYlinear
combination of
,X
which
denoted by:
1Yt is
2 Xstationary,
t t ~ I 0
[1]

The variable set

is called the
Y , X
cointegration set
1 , 2
The coefficients vector
is called the
cointegration vector
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MATHEMATICAL
APPROACH OF
If Equation [1] is normalized, it
COINTEGRATION

Y X
becomes

[2]

2
Xt
1
Yt

is the long-run or
equilibrium value of .

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Cointegrating Vector

It is known that there exists at most one

cointegrating vector (cv)
In the case k = 2, the number of cvs may
be zero or one (r = 0,1) or unique cv.
If we have more than two variables, there
is a possibility of having more than one cv.
When we have a set of k I(1) variables,
there may exist up to k 1 linearly r k 1
independent cv or
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Cointegration in a
Bivariate VAR

Let us consider a first-order

'
Yt , X t
Yt for
(nonstationary) VAR
. That
Yt is
11 12 Yt 1 1t

X t 21 22

X t 1 2t

The matrix 11 is
1 given
12 by
1

21

22 1
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Cointegration in a
Bivariate VAR

If cointegrating vector:
' 11 1 12

The matrix
is given by
1

' 21 11 1 12

11 1
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TESTING FOR
COINTEGRATION
Cointegration in Single equation

The Engle-Granger (EG)

approach.
Cointegration in Multiple
equation The Johansen
approach

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The Engle-Granger (EG)

Approach
Test whether the nonstationary
variables, and , are cointegrated or
spuriously related, we need to
examine the properties of the
regression residuals
for stationarity.
t
If error term ( ) is stationary, Y and
t
Xt are said to be cointegrated.

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The Engle-Granger
Approach

Step 1: Test the variables for their order of

integration using DF or ADF. Both variables
are integrated of the same order.
Step 2: Estimate the long run relationship
using

Yt 1 2 X t t

Step 3: Check for (cointegration) the order

of integration of the residuals. Perform a
DF/ADF on the residual series to determine
the order of integration.
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The Engle-Granger
Approach

Step 3: The form of the DF test is the following:

n

t t 1 i t i t

Critical values fori the

null of no cointegration:
1

1%

5%

10%

No Lags

-4.07

-3.37

-3.30

Lags

-3.73

-3.17

-2.91

Step 4: Estimate the error-correction model.

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