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Granger Causality

It is a statistical hypothesis test for determining whether one time series is useful in forecasting another, taking the lead-lag effect. Regression reflect “Mere” correlation but Clive Granger (Nobel Prize Winner) argued that there is an interpretation of a set of test as revealing something about causality (i.e. cause and effect relation). It tests the cause-effect relation from both sides. If X granger causes Y, then past values of X should contain information that helps predict Y above and beyond the information contained in past values of Y alone. Assumption: o Mean and variance of data does not change over time (data is stationary one) o The data must be explained by linear model. Limitation: if both X and Y are driven by a common 3rd factor, one might still accept the alternative hypothesis of granger causality.

Schwarz Criterion

Also known as “Bayesian Information Criterion” (BIC). It is a criterion for model selection among a finite set of models. It is based on likelihood function. When fitting a model, it is possible to increase the likelihood by adding parameters, by doing so may result in overfitting. The BIC resolves this problem by introducing a penalty term for the number of parameters in the model. It is developed by Gideon E. Schwarz. The lower it is, the better it is.

**Akaike Information Criterion (AIC)
**

It is a measure of relative goodness of fits of a statistical model. It is developed by Hirotsugu Akaike. It provides a means for model selection but it can tell nothing about how well a model fits the data in the absolute sense. Given a set of candidate models for the data, the preferred model is the one with minimum AIC value.

Adjusted R Square

It is the explained variance in the dependent variable by the independent variables, after adjusting for the degree of freedom associated with the sum of squares. It increases only if the new variables improve the model more than would be expected by chance. If adjusted r square is significantly lower than r square, this normally means that some explanatory variable are missing.

there may be cause of alarm. Theil Inequality Coefficient Also known as Theil’s U. Small values of D indicate successive error terms are close in value to one another. Durbin-Watson Statistics It is a test statistics used to detect the presence of autocorrelation (a relationship between values separated from each other by a given time lag) in the residuals from a regression analysis. It assumes that error terms are stationary and normally distributed with mean Zero. It is developed by James Durbin and Geoffrey Watson. Hannan-Quinn Criterion It is a criteria for model selection as an alternative to BIC and AIC. the better it is. It is a good measure of accuracy. if D is less than 1. o D lies between 0 and 4 As a rough rule of thumb . . In our model. there is a evidence of positive serial correlation. If D=Durbin Watson score o D=2: no auto correlation o D<2. provide a measure of how well a time series of estimated values compares to a corresponding time series of observed values. The closer the value of U is to Zero. H0=that the error are serially independent (not autocorrelated) H1= that the errors follows a first order autoregressive process. This is useful for comprising different forecast method. A value of 1 means the forecast is no better than a naïve guess. difference between R square and Adjusted R square is decreasing signifying the improvement in the model. Lower it is . the better the forecast method. The individual difference between estimated and actual values are residuals. Root Mean Squared Error It is a measure of the difference between values predicted by a model or an estimator and the values actually observed. and RMSE serves the aggregate them into a single measure of predictive power.

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