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A0754
Title: The fractionally cointegrated VAR model with threshold adjustment Authors:  Chi Wan Cheang - University of Southampton (United Kingdom) [presenting]
Abstract: The fractional cointegrated vector autoregressive model is extended by allowing two regimes in the speed of adjustment parameter in the error correction term, treating the long run cointegrating vector and the fractional and cofractional orders constant across regimes. Since the threshold parameter is not identified under the null hypothesis of no threshold, a SupLM test for the presence of a threshold is also proposed for fractional cointegration model. The simulations for the null asymptotic distribution and asymptotic $p$-value are discussed. The finite sample performance of the threshold test is examined through a Monte Carlo simulation.The purposed threshold model is applied on the volatility index (VIX) and its related futures. By the fact that investors treat the VIX related products as a security on tailed risk, the products are more attractive in uncertain than in quite time. We argue that the adjustment between volatility index and its futures towards the equilibrium could be regime switching. Empirical tests show that there exists a regime threshold in the adjustment dynamic. The adjustment by VIX futures is negligibly small and insignificant when the error correction term ($s_t-\beta f_t$) is less than or equal to the threshold, but it is highly mean reverting when the error correction is above the threshold. This result may explain the trading behaviour of volatility traders.