Structural Change in Covariance and Exchange Rate Pass-Through: The Case of Canada

The authors address empirically the implications of structural breaks in the variance-covariance matrix of inflation and import prices for changes in pass-through. They define pass-through within a correlated vector autoregression (VAR) framework as the response of domestic inflation to an impulse in import price inflation. This approach allows them to examine changes in both the amount and the duration of pass-through.Econometric and statistical methods

Does Indexation Bias the Estimated Frequency of Price Adjustment?

We assess the implications of price indexation for estimated frequency of price adjustment in sticky price models of business cycles. These models predominantly assume that non-reoptimized prices are indexed to lagged or average inflation. The assumption of price indexation adds tractability although it is not likely reflective of the price practices of firms at the micro level. Under indexation firms have less incentive to adjust their prices, which implies downward bias in the estimated frequency of price changes. To evaluate the bias, we generate data with Calvo-type models without indexation. The artificial data are then used to estimate the frequency of price changes with indexation. Considering different assumptions about the degree of price rigidity and the level of trend inflation in the data-generating model, we find that the estimated indexation bias can be substantial, ranging up to 12 quarters in some cases.Inflation and prices; Economic models; Econometric and statistical methods

A Forecasting Model for Inventory Investments in Canada

The authors present an empirical model to forecast short-run inventory investment behaviour for Canada. As with other recent studies that examine this series, they adopt an error-correction framework. Estimations using non-linear least squares and quarterly data yield both a good model fit and good out-of-sample forecasts. Given the debate in the United States on whether the adoption by firms of new information-technology-based methods of inventory management led to a decline in the volatility of U.S. output growth, the authors examine this issue for Canada. Results of the heteroscedasticity-robust Quandt likelihood ratio test advocated by Stock and Watson (2002) reveal very different dates for structural breaks in the volatilities of the growth contribution of inventory investment and of Canadian output growth: 1984Q1 and 1991Q2, respectively. Thus, the authors conclude that the "inventory hypothesis" is likely not an important explanation for the decline in the volatility of Canadian GDP growth.Domestic demand and components; Econometric and statistical methods

Testing the Stability of the Canadian Phillips Curve Using Exact Methods

Postulating two different specifications for the Canadian Phillips curve (a purely backwardlooking model, and a partly backward-, partly forward-looking model), the authors test for structural breaks in the parameters of the equation. In each case, they account for the possibilities that: (i) breaks can be discrete, or continuous, and (ii) available data samples may be too small to justify using asymptotically valid structural-change tests. Thus, the authors use recent testing procedures that are valid in finite samples, applying the Dufour-Kiviet (1996) methodology for discrete-type breaks, and the Dufour (2002) Maximized Monte Carlo test method for continuous-type shifts. The second test accounts for nuisance parameters that appear only under the alternative. The proposed alternative is a Kalman-filter-based time-varying-parameter specification, with coefficients that follow random walks. The authors find evidence for linear and non-linear breaks, the latter being characterized by continuous and unpredictable-type shifts in the inflation-dynamics coefficients.Econometric and statistical methods

Estimating New Keynesian Phillips Curves Using Exact Methods

The authors use simple new finite-sample methods to test the empirical relevance of the New Keynesian Phillips curve (NKPC) equation. Unlike tests based on the generalized method of moments, the generalized Anderson-Rubin (1949) tests are immune to the presence of weak instruments and allow, by construction, the identification status of a model to be assessed. The authors illustrate their results using Gali and Gertler's (1999) NKPC specifications and data, as well as a survey-based inflation-expectation series from the Federal Reserve Bank of Philadelphia. The test the authors use rejects Gali and Gertler's estimates (conditional on the latters' choice of instruments). Nevertheless, and in contrast with results obtained by Ma (2002), the authors do obtain relatively informative confidence sets. This provides support for NKPC equations and illustrates the usefulness of using exact procedures in estimations based on instrumental variables. The authors' results also reveal that the least well-identified parameter is w; namely, the proportion of firms that do not adjust their prices in period t.Econometric and statistical methods; Inflation and prices

TESTING THE PRICING-TO-MARKET HYPOTHESIS CASE OF THE TRANSPORTATION EQUIPMENT INDUSTRY

Most of the evidence in favor of pricing-to-market (PTM) was obtained by estimating partial equilibrium models using OLS, instrumental variable (IV) and single-equation error-correction methods. However, we know from the recent econometric literature that Wald tests applied to some of these estimates may give erroneous results in the presence of endogeneity and weak instruments. In this paper we examine the reliability of the evidence supporting the hypothesis of pricing-to-market using LIML-based LR Monte Carlo tests. These tests, developed by Dufour and Khalaf (1998), have good power and, unlike the Wald test, also have the correct test size.We first estimate a typical PTM model by OLS and subject certain regressors to a test for exogeneity which does not depend on the "quality" of instruments used. Since the null is rejected, we then re-estimate the model by both IV and limited information maximum likelihood methods. Subsequently, we apply Wald and LR-based tests to the parameters of interest to examine the hypothesis of PTM. We find that the size-correct Monte Carlo LR-based test reverses half of the results obtained from the popular Wald test indicating that PTM may not be as widespread as previously believed. In addition, our results support the viewpoint suggesting that PTM behavior is likely to be present in the same industry across different countries and that pass-through is possibly higher with a larger market share of exports.The above findings are illustrated using the model developed by Marston (1990) and our analysis is conducted for export pricing firms in the transportation equipment industry for three country pairs: Canada exporting to the United States, the United States exporting to Canada, and Japan exporting to (mainly) the United States.

Semi-Structural Models for Inflation Forecasting

We propose alternative single-equation semi-structural models for forecasting inflation in Canada, whereby structural New Keynesian models are combined with time-series features in the data. Several marginal cost measures are used, including one that in addition to unit labour cost also integrates relative price shocks known to play an important role in open-economies. Structural estimation and testing is conducted using identification-robust methods that are valid whatever the identification status of the econometric model. We find that our semi-structural models perform better than various strictly structural and conventional time series models. In the latter case, forecasting performance is significantly better, both in the short run and in the medium run.Inflation and prices; Econometric and statistical methods

Shift Contagion in Asset Markets

The authors develop a new methodology to investigate how crises cause the relationship between financial variables to change. Two possible sources of increased co-movement between markets during high-variance episodes are considered: larger common shocks operating through standard market linkages, and a structural change in the propagation of shocks between markets, called “shift contagion.” The methodology has three key features: (i) high- and low-variance episodes are model-determined, rather than exogenously assigned; (ii) the markets where crises originate need not be known; and (iii) the approach provides an unambiguous test of shift contagion. Applications to bivariate returns in currency markets of developed countries and bond markets of emerging-market countries suggest that shift contagion occurs among the former but not the latter.Financial markets; Econometric and statistical methods

On the Dynamic Specification of International Asset Pricing Models

In this paper, we test the international conditional CAPM model of Dumas and Solnik (1993) and the international conditional APT model of Ferson and Harvey (1992), as well as various extensions of these models. These models were typically estimated by GMM and found to be valid according to the standard J-test. Given to the low power of J-tests against many specific alternatives, we propose several diagnostics to further scrutinize the empirical fit of these models. We show that although they could not be rejected on the basis of the overidentifying restrictions test, they are not very useful for consistently predicting the conditional first and second moments of equity and foreign exchange returns over time. Our specification search leads us to an alternative international conditional CAPM model with a factor ARCH formulation for modelling international returns for which we find strong support, both with the J-statistic criterion, as well as a number of other diagnostics tests, including tests for parameter stability, orthogonality of residuals and explicit analysis of pricing errors. Dans ce papier, nous testons le modèle CAPM conditionnel international de Dumas et Solnik, l'APT conditionnel international de Ferson et Harvey, ainsi que plusieurs extensions de ces modèles. Ceux-ci ont habituellement été estimés par la méthode des moments généralisés et un test J standard n'a souvent pas permis de rejeter les spécifications retenues. Cependant, étant donnée la faible puissance de ces tests contre certaines alternatives locales, nous proposons d'autres tests de diagnostique pour approfondir l'examun empirique de ces modèles. Nous montrons que même si ces derniers n'ont pas été rejeté par le test J , ils ne sont pas très utiles pour prévoir les premier et second moments des rendements des actions et du taux de change. Notre recherche nous mène à une spécification alternative pour modéliser le rendement des actifs internationaux qui est la formulation ARCH à facteurs. Pour cette dernière, nous trouvons beaucoup de support empirique, à la fois avec le test J et avec un certain nombre d'autres tests de diagnostique comme un test d'orthogonalité des résidus ou un examun systématique des erreurs sur les prix.generalized method of moments, diagnostc tests, international conditional CAPM, international conditional APT, factor ARCH, méthode des moments généralisée, tests de diagnostique, CAPM conditionnel international, APT conditionnel international, ARCH à facteurs.

Structural Change and Forecasting Long-Run Energy Prices

The authors test the statistical significance of Pindyck’s (1999) suggested class of econometric equations that model the behaviour of long-run real energy prices. The models postulate meanreverting prices with continuous and random changes in their level and trend, and are estimated using Kalman filtering. In such contexts, test statistics are typically non-standard and depend on nuisance parameters. The authors use simulation-based procedures to address this issue; namely, a standard Monte Carlo test and a maximized Monte Carlo test. They find statistically significant instabilities for coal and natural gas prices, but not for crude oil prices. Out-of-sample forecasts are calculated to differentiate between significant models.Econometric and statistical methods