Threshold vector error correction model and transaction cost variation

• Published in: Applied economics Vol. 56; no. 42; pp. 5058 - 5071
• Main Authors: Machado, Pedro C., Chung, Chanjin, Ng'ombe, John N.
• Format: Journal Article
• Language: English
• Published: London Routledge 07-09-2024; Taylor & Francis Ltd
• Subjects: Adjustment; Butter; Cointegration; Economic analysis; Equilibrium; Error correction & detection; flexible threshold model; Linear analysis; Monte carlo simulation; Performance evaluation; Specification; threshold vector error correction model; transaction cost; Transaction costs; Violations
• ISSN: 0003-6846; 1466-4283
• DOI: 10.1080/00036846.2023.2244238

Our study assesses the performance of a threshold vector error correction model (TVECM) for the analysis of spatial price transmission. We specifically determine how inference about price regimes and the process of price adjustment to the established long-run equilibrium is affected when the stochastic transaction cost is exogenously or endogenously determined in fixed and flexible threshold models. The study first generates non-stationary but cointegrated price series and transaction costs based on true price transmission parameters: percentage of violations of spatial equilibrium, speed of price adjustment, threshold and inaction band using Monte Carlo simulations. Then, the generated data are used to estimate TVECMs under various assumptions on transaction cost variation and threshold specification. Finally, estimates of price transmission parameters are compared with the true parameters to evaluate the performance of model specifications. Our results indicate that the flexible TVECM accounting for transaction cost variation outperforms the standard fixed TVECM, which is consistent with findings from many previous studies in the literature. Our study also finds that although the flexible TVECM performs better than the fixed TVECM, it may not fully address the limitation of linear models when a real-world data represents a complex nonlinearity in the spatial price transmission.