Suppose a young researcher would like to analyze the relationship between Gross Domestic  Product (GDP), foreign direct investment (FDI), and trade openness (OPEN), where GDP  is theoretically modeled to be affected by both FDI and OPEN but not the opposites. 

a) Based on the above, list the steps to examine the long-run relationship among the  variables by using Engle-Granger procedures. Then, write the necessary equations  and hypothesis testing that identify their relationship. 

 

b) Assume GDP, FDI and OPEN do not move together in the long run, but OLS  estimation output reveals a significant effect of FDI but not OPEN on GDP. What  does the result imply?

 

c) Following assumption in b), could a researcher proceed with examining short-run  causality among the variables. If not, why? If yes, how?

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1 The null hypothesis is that the series in yt are not cointegrated so if the residual test fails to find evidence against the null of a unit root the EngleGranger test fails to find evidence that the ... View the full answer