CEE 4221 Study Guide - Quiz Guide: 2-Step Garage, Spot Contract, Ftse 100 Index
27 May 2016
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The fair futures price is given by where ft. Taking logarithms of both sides of equation above gives. Dickey-fuller tests on log-prices and returns for high frequency ftse data. Conclusion: log ft and log st are not stationary, but log ft and log st are stationary. But a model containing only first differences has no long run relationship. Solution is to see if there exists a cointegrating relationship between ft and st which would mean that we can validly include levels terms in this framework. Potential cointegrating regression: where zt is a disturbance term. Estimate the regression, collect the residuals, , and test whether they are stationary. Conclusion: are stationary and therefore we have a cointegrating relationship between log ft and log st. Final stage in engle-granger 2-step method is to use the first stage residuals, as the equilibrium correction term in the general equation.
