Suppose the two variables, x and y, are integrated of order one, and their linear combination is tested using the Augmented Dickey–Fuller (ADF) test, yielding the following results: test statistic = −4.15 and critical value = −3.97.
You want to construct either
(a) an Error Correction Model (ECM) , or
(b) a model in differences :

Which model is most appropriate?

Question

Suppose the two variables, x and y, are integrated of order one, and their linear combination is tested using the Augmented Dickey–Fuller (ADF) test, yielding the following results: test statistic = −4.15 and critical value = −3.97. 
 You want to construct either 
 (a) an  Error Correction Model (ECM) , or 
 (b) a  model in differences : 
  
 Which model is most appropriate?

Accepted Answer

Since both time series are integrated of the same order and there is a cointegration relationship, the ECM model is preferred.

Answer

Since both time series are integrated of the same order, we should use the ECM model right away, no matter what the ADF test tells us.

Answer

We should use the model on differences since no cointegration relationship was found.

Answer

Both time series are integrated of the first order. We should test the time series for cointegration, and the Breusch–Godfrey test is appropriate for this.

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Suppose the two variables, x and y, are integrated of order one, and their lin...

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