Cointegration and market efficiency

Abstract Recently, many economists have asserted that asset prices determined in efficient asset markets cannot be cointegrated. We show that there is no general equivalence between the existence of arbitrage opportunities and cointegration or, for that matter, a lack of cointegration. Whether asset prices are cointegrated is a function of the relevant model. We first show a convenient way to calculate the cointegrating vector based on necessary and sufficient conditions for cointegration. We then examine particular cases, including exchange rates, interest rates and spot and forward exchange rates, and asset prices with incoem flows reinvested and not reinvested. (JEL F31)

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