Specification of VECMs

Abstract

In specifying VECMs, the lag order, the cointegration rank and possibly further restrictions have to be determined. The lag order and the cointegration rank are typically determined before further restrictions are imposed on the parameter matrices. Moreover, the specification of a VECM usually starts by determining a suitable lag length because, in choosing the lag order, the cointegration rank does not have to be known, whereas many procedures for specifying the cointegration rank require knowledge of the lag order. Therefore, in the following, we will first discuss the lag order choice (Section 8.1) and then consider procedures for determining the cointegration rank (Section 8.2). We will comment on subset modelling in a VECM framework in Section 8.3 and, in Section 8.4, we will discuss checking the adequacy of such models. More precisely, residual autocorrelation analysis, testing for nonnormality and structural change are dealt with.