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Modeling Regional Interdependencies Using a Global Vector Error-Correcting Macroeconometric Model

M. Hashem Hashem Pesaran

University of Southern California

Scott M. Weiner

Alliance Capital Management

Til Schuermann

Oliver Wyman

October, 2001

Wharton Financial Institutions Center Working Paper No. 01-38

A financial institution such as a bank is ultimately exposed to macroeconomic fluctuations in the countries to which it has exposure, the most acute example being commercial lending to companies whose fortunes fluctuate with aggregate demand. It was this risk management need for financial institutions which motivated us to build a compact global macroeconometric model capable of generating (point as well as density) forecasts for a core set of macroeconomic factors for a set of regions and countries which explicitly allows for interconnections and dependencies that exist between national and international factors in a coherent and consistent manner. This paper provides such a global modeling framework by making use of recent advances in the analysis of cointegrating systems. In an unrestricted VAR model covering N countries/regions, the number of unknown parameters will be unfeasibly large (around p(4N-1)+1, where p is the order of the VAR), requiring a more parsimonious solution. We first estimate individual country (or region) specific vector error correcting models, where the domestic macroeconomic variables are related to corresponding foreign variables constructed exclusively to match the international trade pattern of the country under consideration. The individual country models are then combined in a consistent and cohesive manner to generate forecasts for all the variables in the world economy simultaneously. We estimate the model using quarterly data from 1979Q1 to 1999Q1 and perform contagion analysis by investigating the transmission of shocks of one variable to the rest of the world.

Number of Pages in PDF File: 56

Keywords: Economic interlinkages, global macroeconometric modeling, risk management

JEL Classification: C320, E170, G200

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Date posted: December 14, 2001  

Suggested Citation

Pesaran, M. Hashem Hashem and Weiner, Scott M. and Schuermann, Til, Modeling Regional Interdependencies Using a Global Vector Error-Correcting Macroeconometric Model (October, 2001). Wharton Financial Institutions Center Working Paper No. 01-38. Available at SSRN: http://ssrn.com/abstract=293714 or http://dx.doi.org/10.2139/ssrn.293714

Contact Information

M. Hashem Hashem Pesaran (Contact Author)
University of Southern California ( email )
Los Angeles, CA 90089
United States
Scott M. Weiner
Alliance Capital Management ( email )
1345 Avenue of the Americas
New York, NY 10105
United States
212-969-6077 (Phone)
212-969-2226 (Fax)
Til Schuermann
Oliver Wyman ( email )
1166 6th Avenue
New York City, NY
United States
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