An I(2) Cointegration Analysis of Small-Country Import Price Determination

This paper develops a procedure for testing hypotheses on the full set of cointegration parameters of the I(2) model. The proposed test is applied to the analysis of small-country import price determination extending the standard empirical framework to allow for variables integrated of order two. The empirical analysis of Danish data for 1975 to 1995 yields a fully specified I(2) long-run structure in terms of stationary pricing-to-market and inventory relations, a nominal second-order stochastic trend embodied in equal proportions in domestic and foreign price levels, and a real first-order trend driving the relative prices and the real interest rate.