Self-Generating Variables in a Cointegrated VAR Framework
UCSD Economics Discussion Paper No. 2001-04
Posted: 25 Jul 2001
Date Written: February 2001
Abstract
A variable is defined to be self-generating if it can be forecast efficiently from its own past only. Conditions are derived for certain linear combinations to be self-generating in error correction models. Interestingly, there are only two candidates for self-generation in an error correction model. They are cointegrating relationships and common stochastic trends defined by Gonzalo and Granger (1995). The usefulness of self-generation as a multivariate-modelling tool is investigated. A simple testing procedure is also presented. Some interesting economic hypothesis can be easily tested in the self-generation framework. For example, for forward exchange rate to have forecasting power for the future movements in spot rate, the latter should not be self-generating. Given that they are cointegrated, the spot exchange rate should not be a common stochastic trend, which can be easily tested. We also provide additional examples.
Keywords: Self-Generation, Cointegrated VAR, Common Stochastic Trends, Aggregation of Time Series, Efficiency of Forecasting
JEL Classification: C22, C32
Suggested Citation: Suggested Citation