Testing the fed and the Graham & Dodd models: asymmetric vs. symmetric adjustment

Abstract

We examine the empirical validity of the Fed model and the Graham & Dodd model for five countries and over a time period spanning three decades by applying the Enders and Granger (1998) and Enders and Siklos (2001) threshold unit-root and cointegration tests. Our results support the hypothesis that the adjustment back to equilibrium is asymmetric.

Notes

¹ See, e.g. ‘Valuation Check’, Trilogy Advisors, by Bill Sterling (June 2005). <www.trilogyadvisors.com>

² The estimated residuals from the estimated cointegration relationship are sorted in ascending order. The largest and smallest 15% of these values are discarded and each of the remaining 70% of estimated residuals are considered as possible thresholds. For each of these possible thresholds, we estimates by ordinary least square an equation in the form of (3.4) and (3.5). The estimated threshold yielding the lowest residual sum of squares is deemed the appropriate estimate of the threshold. The lag-length p in Equation 1 is determined via Hall's (1994) general-to-specific approach starting with a maximum lag-length of p = 8.

³ Preliminary test, results indicate that both E/P and Y are I(1).