This paper studies the asymptotic properties of instrumental variable (IV) estimates of multivariate cointegrating regressions. The framework of study is based on earlier work by Phillips and Durlauf (1986) and Park and Phillips (1988, 1989). In particular, the results in these papers are extended to allow for IV regressions that accommodate deterministic and stochastic regressors as well as quite general deterministic processes in the data generating mechanism. It is found that IV regressions are consistent even when the instruments are stochastically independent of the regressors. This phenomenon, which contrasts with traditional theory for stationary time series, is a beneficial artifact of spurious regression theory whereby stochastic trends in the instruments ensure their relevance asymptotically. Problems of inference are also addressed and some promising new theoretical results are reported. These involve a class of Wald tests which are modified by semiparametric corrections for serial correlation and for endogeneity. The resulting test statistics which we term fully modified Wald tests have limiting chi-squared distributions, thereby removing the obstacles to inference in cointegrated systems that were presented by the nuisance parameter dependencies in earlier work. Interestingly, IV methods themselves are insufficient to achieve this end and an endogeneity correction is still generally required, again in contrast to traditional theory. Our results therefore provide strong support for the conclusion reached by Hendry (1986) that there is no free lunch in estimating cointegrated systems. Some simulation results are reported which seek to explore the sampling behavior of our suggested procedures. These simulations compare our fully modified (semiparametric) methods with the parametric error correction methodology that has been extensively used in recent empirical research and with conventional least squares regression. Both the fully modified and error correction methods work well in finite samples and the sampling performance of each procedure confirms the relevance of asymptotic distribution theory, as distinct from superconsistency results, in discriminating between different statistical methods.
