Cointegration refers to a statistical property of a collection of time series variables that indicates a long-run equilibrium relationship among them, despite being non-stationary individually. In simpler terms, if two or more time series are cointegrated, they may wander over time but their paths will remain closely related, maintaining a stable relationship in the long run. This concept is crucial in econometrics because it allows for the modeling of relationships between economic variables that are both trending over time, such as GDP and consumption.
The most common test for cointegration is the Engle-Granger two-step method, where the first step involves estimating a long-run relationship, and the second step tests the residuals for stationarity. If the residuals from the long-run regression are stationary, it confirms that the original series are cointegrated. Understanding cointegration helps economists and analysts make better forecasts and policy decisions by recognizing that certain economic variables are interconnected over the long term, even if they exhibit short-term volatility.
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