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

Author

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  • T.J. Brailsford

    (UQ Business School, University of Queensland, Australia)

  • J. H.W. Penm

    (The Australian National University, Australia)

  • R.D. Terrell

    (The Australian National University, Australia)

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. We show that causality detection in an I(d) system can be discovered identically from the ZNZ patterned VECM’s or the equivalent VAR models.

Suggested Citation

  • T.J. Brailsford & J. H.W. Penm & R.D. Terrell, 2006. "The Equivalence of Causality Detection in VAR and VECM Modeling with Applications to Exchange Rates," Multinational Finance Journal, Multinational Finance Journal, vol. 10(3-4), pages 153-178, September.
    • Handle: RePEc:mfj:journl:v:10:y:2006:i:3-4:p:153-178
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    More about this item

    Keywords

    error correction models; VAR; granger causality; purchasing power parity;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • F30 - International Economics - - International Finance - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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