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Hansen(2006, Econometrics)

# Hansen(2006, Econometrics)

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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
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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