Cointegration Test With Stationary Covariates And The CDS-Bond Basis During The Financial Crisis
This paper proposes a residual based cointegration test with improved power. Based on the idea of Hansen (1995) and Elliott & Jansson (2003) in the unit root testing case, stationary covariates are used to improve the power of the residual based Augmented Dickey Fuller (ADF) test. The asymptotic null distribution contains difficult to estimate nuisance parameters for which there is no obvious method of estimation, therefore the authors propose a bootstrap methodology to obtain test critical values. Local-to-unity asymptotics and Monte Carlo simulations are used to evaluate the power of the test in large and small samples, respectively.