Publication: Permanent and transitory components of GDP and stock prices: further analysis
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ISSN: 1752-0851 (online)
ISSN: 1752-0843 (print)
Publication date
2008
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Taylor & Francis
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Abstract
Using the conventional VAR identification approach, Cochrane (Quarterly Journal of Economics 107: 241-65, 1994) finds that substantial amounts of variation in GDP growth and stock returns are due to transitory shocks. Following the common trend decomposition of King etal. (American Economic Review 81: 819-40, 1991), we show that Cochrane's results depend on the assumption of weak exogeneity of one of the variables with respect to the cointegration vector. When this assumption holds both approaches coincide. If not, the shocks Cochrane called transitory are not totally transitory. In this case, the conventional VAR approach with the assumption of the weak exogeneity may overstate the magnitude of transitory shocks and understate that of permanent shocks. We find that the permanent components of GDP and stock prices are much larger than those estimates of Cochrane, although substantial (but much smaller than in Cochrane 1994) variations in GDP growth and stock returns are attributed to transitory shocks.
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Keywords
Permanent components, Transitory components, Weak exogeneity, Cointegration, VAR
Bibliographic citation
Macroeconomics and Finance in Emerging Market Economies, vol.1, issue 1, march 2008, p. 105-120