FINITE-SAMPLE PROPERTIES OF LIKELIHOOD RATIO TESTS FOR COINTEGRATING RANKS WHEN LINEAR TRENDS ARE PRESENT

This paper investigates the finite sample properties of likelihood ratio tests for ''stochastic cointegration'' that have recently been proposed by Johansen and Perron and Campbell. We transform the model into a canonical form and conduct a comprehensive simulation study. We find that the test performance is very sensitive to the value of the stationary root(s) of the process and to the correlation between the innovations that drive the stationary and nonstationary components of the process. Unfortunately, the simulation results suggest that these asymptotic test procedures are not very powerful for sample sizes that are typical for economic time series.