Are retail prices of ethanol, gasoline and natural gas in the midwest cointegrated? An asymmetric threshold cointegration analysis

This paper examines whether there is a long run equilibrium relationship, and the short run dynamic adjustment of such a relationship between the retail prices of selected transportation fuels in the Midwest. The study uses monthly data for the period October 2006 to December 2013. The analysis involves the nonlinear Threshold Autoregressive (TAR) and the Momentum Threshold Autoregressive (M-TAR) models of threshold cointegration, and the Momentum Threshold Vector Error Correction Models (M-TVECM), after pretesting for nonlinearities. The empirical results provide an unambiguous evidence of cointegration and asymmetric adjustments to the long run equilibrium relationship following deviations from the empirically estimated thresholds. There is robust empirical evidence of bi-directional Granger causality. There is empirical evidence that shocks to ethanol have lasting effects on gasoline prices than a corresponding shock to gasoline on ethanol prices. The empirical results have huge policy implications for the current debate on the future of the Renewable Fuel Standards (RFS) mandate in the United States.