When time series are observed with noise, the popular Augmented Dickey–Fuller (ADF) unit root test and Johansen's cointegration test are oversized: the ADF tends to conclude for stationarity too often and Johansen's test finds too many cointegrating relations. This fact is well-known but no simple solution has been proposed in the literature. In this work, we show why this happens and prove theoretically and by Monte Carlo simulations how three different filtering approaches can significantly improve the performance of the two tests applied to noisy data without harming their properties when observations are free from noise. We show how conclusions can change when using filtered time series in two real applications: one concerning wholesale electricity prices in European countries, and the second warning against pairs trading strategies based on spurious cointegrating relations among stock prices.

Gianfreda, A., Maranzano, P., Parisio, L., Pelagatti, M. (2023). Testing for integration and cointegration when time series are observed with noise. ECONOMIC MODELLING, 125(August 2023) [10.1016/j.econmod.2023.106352].

Testing for integration and cointegration when time series are observed with noise

Maranzano, Paolo;Parisio, Lucia;Pelagatti, Matteo
2023

Abstract

When time series are observed with noise, the popular Augmented Dickey–Fuller (ADF) unit root test and Johansen's cointegration test are oversized: the ADF tends to conclude for stationarity too often and Johansen's test finds too many cointegrating relations. This fact is well-known but no simple solution has been proposed in the literature. In this work, we show why this happens and prove theoretically and by Monte Carlo simulations how three different filtering approaches can significantly improve the performance of the two tests applied to noisy data without harming their properties when observations are free from noise. We show how conclusions can change when using filtered time series in two real applications: one concerning wholesale electricity prices in European countries, and the second warning against pairs trading strategies based on spurious cointegrating relations among stock prices.
Articolo in rivista - Articolo scientifico
Cointegration; Electricity prices; Filtering; Pairs trading; Stationarity; Unit root;
English
10-mag-2023
2023
125
August 2023
106352
embargoed_20260510
Gianfreda, A., Maranzano, P., Parisio, L., Pelagatti, M. (2023). Testing for integration and cointegration when time series are observed with noise. ECONOMIC MODELLING, 125(August 2023) [10.1016/j.econmod.2023.106352].
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10281/415576
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