Granger-Causality in Markov Switching Models
20 Pages Posted: 28 Nov 2006
Date Written: March 2006
In this paper we propose a new parametrisation of transition probabilities that allows us to characterize and test Granger-causality in Markov switching models by means of an appropriate specification of the transition matrix. Test for independence are also provided. We illustrate our methodology with an empirical application. In particular, we investigate the causality and interdependence between financial and economic cycles using a bivariate Markov switching model. When applied to U.S. data, we find that financial variables are useful for forecasting the direction of aggregate economic activity, and vice versa.
Keywords: Granger Causality, Markov Chains, Switching Models
JEL Classification: C53, C32
Suggested Citation: Suggested Citation