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Hansen(2006, Econometrics)

Hansen(2006, Econometrics)

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Published by: moimemevollbio on Jul 11, 2012
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07/11/2012

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Partition the data vector into (Yt,Zt). Define the two information sets

I1t = (Yt,Yt−1,Yt−2,...)
I2t = (Yt,Zt,Yt−1,Zt−1,Yt−2,Zt−2,,...)

The information set I1t is generated only by the history of Yt, and the information set I2t is
generated by both Yt and Zt. The latter has more information.
We say that Zt does not Granger-cause Yt if

E(Yt | I1,t−1) = E(Yt | I2,t−1).

That is, conditional on information in lagged Yt, lagged Zt does not help to forecast Yt. If this
condition does not hold, then we say that Zt Granger-causes Yt.
The reason why we call this “Granger Causality” rather than “causality” is because this is not
a physical or structure definition of causality. If Zt is some sort of forecast of the future, such as a
futures price, then Zt may help to forecast Yt even though it does not “cause” Yt. This definition
of causality was developed by Granger (1969) and Sims (1972).
In a linear VAR, the equation for Yt is

Yt = α+ρ1Yt−1 +···+ρkYtk +Z0t−1γ1 +···+Z0tkγk +et.

In this equation, Zt does not Granger-cause Yt if and only if

H0 : γ1 = γ2 = ··· = γk = 0.

This may be tested using an exclusion (Wald) test.
This idea can be applied to blocks of variables. That is, Yt and/or Zt can be vectors. The
hypothesis can be tested by using the appropriate multivariate Wald test.
If it is found that Zt does not Granger-cause Yt, then we deduce that our time-series model of
E(Yt | It−1) does not require the use of Zt. Note, however, that Zt may still be useful to explain
other features of Yt, such as the conditional variance.

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