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The Johansen Cointegration Test helps identify whether a long-term equilibrium relationship exists between two or more non-stationary time series. It is commonly applied in financial models, such as exploring the dynamic link between stock index futures and spot indices.
Key insights from the Johansen Test include:
1. Trace Test: Determines the number of cointegrating vectors, checking whether the hypothesis of no cointegration can be rejected.
2. Maximum Eigenvalue Test: Compares the largest eigenvalue to determine cointegration rank.
The test utilizes two main assumptions:
The variables must be integrated of the same order.
A Vector Error Correction Model (VECM) can explain both short-term deviations and long-term equilibrium behavior.
For instance, in a study analyzing SSE 50 Stock Index Futures and its spot index, findings confirmed a long-term equilibrium link using this method. Cointegration models like these are essential in trading and hedging strategies as they allow traders to exploit arbitrage opportunities and improve portfolio management (source: EUDL).
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