Cointegration and Causality between the Real and the Financial Variables: Evidence from the Korean Economy

This paper uses the multivariate cointegration technique proposed by Johansen (1988) and Johansen and Juselius (1990) to examine the linkage between the real and financial variables in Korea. Johansen cointegration test supports the long run equilibrium relationship between the financial sector and the real sector by showing one cointegrating vector. Using this cointegrating vector, some of the lagged industrial productivity, stock return, and exchange rate show statistically significant short-run effects on the industrial productivity. Especially, exchange rate and stock index have significant effect on industrial production in the short run. The reason is that Korea is an export-dominant country so currency depreciation can increase the exports of firms. In addition, the Chow test shows that there is a structuralinstability in Korea while the Asian financial crisis happened.