Cointegration and Common Factors

Abstract

Abstract. Alternative common factor representations for cointegrated vectors are studied. This is done by embedding them into the dynamic factor model proposed by Peña and Box (Identifying a simplifying structure in time series. J. Am. Statist. Assoc. 82 (1987), 836?43). It is shown that dynamic factor models produce as a particular case the alternative common trend representations for cointegrated variables available in the literature. Furthermore a new normalization is proposed which has the advantage of producing common trend representations with moving-average polynomials and under certain circumstances with uncorrelated shocks.