The Equivalence of Causality Detection in VAR and VECM Modeling with Applications to Exchange Rates

25 Pages Posted: 30 Jun 2015

See all articles by Tim Brailsford

Tim Brailsford

Bond University

Jack H.W. Penm

Australian National University - School of Finance and Applied Statistics, Faculty of Economics and Commerce

R. Deane Terrell

Australian National University (ANU) - National Graduate School of Management

Date Written: June 30, 2015

Abstract

Vector error-correction models (VECM) are increasingly being used to capture dynamic relationships between financial variables. Estimation and interpretation of such models can be enhanced if zero restrictions are allowed in the coefficient matrices. Specifically, in tests of indirect causality and/or Granger non-causality in a VECM, the efficiency of the causality detection is crucially dependent upon finding zero coefficient entries where the true structure does indeed include zero entries. Such a VECM is referred to as a zero-non-zero (ZNZ) patterned VECM and includes full-order models. Recent advances have shown how ZNZ patterns can be explicitly recognized in a VECM and used to provide an effective means of detecting Granger-causality, Granger non-causality and indirect causality. This paper develops a general approach and framework for I(d) integrated systems.

Keywords: error correction models; VAR; granger causality; purchasing power parity

JEL Classification: C10, C63, F30, G10

Suggested Citation

Brailsford, Timothy John and Penm, Jack and Terrell, R. Deane, The Equivalence of Causality Detection in VAR and VECM Modeling with Applications to Exchange Rates (June 30, 2015). Multinational Finance Journal, Vol. 10, No. 3/4, p. 153-177, 2006, Available at SSRN: https://ssrn.com/abstract=2625012

Timothy John Brailsford (Contact Author)

Bond University ( email )

Gold Coast, QLD 4229
Australia

HOME PAGE: http://www.bond.edu.au

Jack Penm

Australian National University - School of Finance and Applied Statistics, Faculty of Economics and Commerce ( email )

Canberra, Australian Capital Territory 0200
Australia
+61 (02) 61250535 (Phone)
+61 (02) 61250087 (Fax)

R. Deane Terrell

Australian National University (ANU) - National Graduate School of Management ( email )

Sir Roland Wilson Building (120)
Canberra, Australian Capital Territory 0200
Australia

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