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Interpreting an error correction model: Partial adjustment, forward‐looking behaviour, and dynamic international money demand
Author(s) -
Domowitz Ian,
Hakkio Craig S.
Publication year - 1990
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.3950050103
Subject(s) - error correction model , context (archaeology) , error detection and correction , nesting (process) , econometrics , economics , mathematical economics , dynamic programming , rational expectations , cointegration , counterintuitive , variable (mathematics) , computer science , mathematical optimization , mathematics , algorithm , paleontology , philosophy , mathematical analysis , materials science , epistemology , metallurgy , biology
An error correction model is derived from a stochastic dynamic programming problem incorporating rational expectations. A parametric restriction is derived that allows a test for the theoretical proposition that the optimal strategy behind the error correction from entails the failure to asymptotically close the gap between the choice variable and the growing target. This is accomplished by nesting a partial adjustment model with forward‐looking expectations within the error correction paradigm. The counterintuitive behaviour embodied in the error correction model is not supported by the data in the context of a cross‐country comparison of cash balances relationships.