TESTING MARKET EQUILIBRIUM: IS COINTEGRATION INFORMATIVE?

Cointegration methods are increasingly used to test for market efficiency and integration. The economic rationale for these tests, however, is generally unclear. Using a simple spatial equilibrium model to simulate equilibrium price behavior, it is shown that prices in a well-integrated, efficient market need not be cointegrated. Furthermore, the number of cointegrating relationships among prices is not a good indicator of the degree to which a market is integrated.