Assume that you are trying to model the relationship between house prices and rents. If you find that both series are non-stationary and a linear combination of the two series is stationary, which of the following is true?
(I) Regressing the levels of house prices on the levels of rents could lead to spurious regressions
(II) House prices and rents are cointegrated
(III) An appropriate linear combination of house prices and rents is I(1)
(IV) House prices and rents are not cointegrated
A) I only
B) I and II only
C) I, II and III only
D) I, II, III and IV only

Question

Quizplus · Accepted Answer

I and II are correct. If both series are non-stationary but a linear combination of them is stationary, it indicates cointegration, meaning there is a long-term equilibrium relationship between them. This also implies that regressing one on the other without considering their non-stationarity could lead to spurious regression results. III is incorrect because the stationary linear combination implies that the series are integrated of order 0, I(0), not I(1). IV is incorrect because stating that the series are not cointegrated contradicts the premise that a stationary linear combination exists.

Assume That You Are Trying to Model the Relationship Between