The failure of financial econometrics: Assessing the cointegration "revolution"

One aspect of the failure of financial econometrics is the use of cointegration analysis for financial decision making and policy analysis. This paper demonstrates that the results obtained by using different cointegration tests vary considerably and that they are not robust with respect to model specification. It is also demonstrated that, contrary to what is claimed, cointegration analysis does not allow distinction between spurious relations and genuine ones. Some of the pillars of cointegration analysis are not supported by the results presented in this study. Specifically it is shown that cointegration does not necessarily imply, or is implied by, a valid error correction representation and that causality is not necessarily present in at least one direction. More importantly, however, cointegration analysis does not lead to sound financial decisions, and a better job can be done by using simple correlation analysis.