TOPIC 8:
APPLICATION OF VAR
MODEL
By:
Assoc. Prof. Dr. Sallahuddin Hassan
SEEQ5133
Applied Econometrics
INTRODUCTION
2
Some analysis using VAR model:
Impulse response functions
(IRFs)
Variance decomposition
Granger causality
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ECONOMETRICS
APPLIED
IMPULSE RESPONSE
FUNCTION
Impulse response function (IRF)
shows the effects of shocks on the
adjustment path of the variable.
Examines the response of the
dependent variable to shocks in the
error term or exogenous shock:
nominal and real shock
domestic and external shocks
permanent and transitory shocks
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IMPULSE RESPONSE
FUNCTION
Pattern of coefficients are IRFs.
IRFs depict:
how the shock spread up over time.
the response of each variable taken in level
to a 1% shock as well as the confidence
interval.
Eviews implementation:
Select View/Impulse and in impulse
definition tab choose residuals-one std.
deviation
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ECONOMETRICS
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IMPULSE RESPONSE
FUNCTION - VECM
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APPLIED
IMPULSE RESPONSE
FUNCTION - VECM
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APPLIED
FORECAST ERROR
VARIANCE DECOMPOSITION
Forecast error variance decomposition
(FEVD) explains the proportion of the
movements in a sequence due to its own
shocks versus shocks to other variable.
FEDV:
enables to determine the most fluctuation
sources of the endogenous variables for the
period of study
permits to measure the part of the anticipated
variance of each endogenous variable explained
by the different shocks for the different horizons.
SEEQ5133
APPLIED
FORECAST ERROR
VARIANCE DECOMPOSITION
Variable that is expected to have any
predictive value for other variables
should be put last.
The percentage of variation depends
on:
Correlation between the residuals of a
variable and the residuals of variable
that appear before it in the ordering.
Correlation among innovation.
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FORECAST ERROR
VARIANCE DECOMPOSITION
- VECM
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APPLIED
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FORECAST ERROR
VARIANCE DECOMPOSITION
- VECM
Variance Decompos ition of REXP_M:
Perio...
S.E.
REXP_M
RFDI_M
RGDP_M
1
2
3
4
5
6
7
8
9
10
61904059
99067994
1.31E+08
1.59E+08
1.84E+08
2.07E+08
2.28E+08
2.48E+08
2.67E+08
2.87E+08
100.0000
95.98935
95.74035
96.09691
96.56349
96.92545
97.03860
96.80910
96.17334
95.09092
0.000000
2.341486
2.541552
2.180861
1.715001
1.363373
1.267284
1.520893
2.188272
3.310043
0.000000
1.669160
1.718093
1.722232
1.721512
1.711182
1.694112
1.670005
1.638391
1.599041
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APPLIED
RESULT OF ANALYSIS
11
In the short run, impulse of
innovation or shock to REXP
account for 100 percent
variation of the fluctuation in
REXP (own shock).
Shock to RFDI and RGDP can
cause 0.00 percent in the first
period.
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RESULT OF ANALYSIS
12
In the long run, impulse of
innovation or shock to REXP
account for 95.09 percent
variation of the fluctuation in
REXP (own shock).
Shock to RFDI and RGDP can
cause 3.31% and 1.59%.
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CAUSALITY
13
Refers to the ability of one
variable to predict (and
therefore cause) the other.
Suppose Yt and Xt affect each
other with distributed lags.
This relationship can be
captured by a VAR model.
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CAUSALITY
14
Granger (1969) developed
causality test:
A variable Yt is said to Grangercauses Xt ,
if Xt can be predicted with greater
accuracy by using past values of the
Yt rather than not using such past
values, all other terms remaining
unchanged.
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CAUSALITY
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Yt 1 i X t i jYt j 1t
i 1
N
j 1
M
X t 1 i X t i jYt j 2 t
i 1
j 1
i 1
j 1
Yt 1 i X t i jYt j 1 ECTt 1 1t
N
i 1
j 1
X t 1 i X t i jYt j 2 ECTt 1 2t
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DIRECTION OF
CAUSALITY
Unidirectional causality from Yt to Xt.
The estimated coefficients on the lagged X in Equation
1 is statistically significant. Variable X (Granger) causes
Y.
The estimated coefficients on the lagged Y in Equation
2 is not statistically significant.
Unidirectional causality from Xt to Yt.
The estimated coefficients on the lagged X in Equation
1 is not statistically significant.
The estimated coefficients on the lagged Y in Equation
2 is statistically significant. Variable Y (Granger) causes
X.
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DIRECTION OF
CAUSALITY
Bilateral causality of Feedback.
The set of lagged Y and X coefficients
are statistically significant different
from zero in both regression.
Independence.
The set of lagged Y and X coefficients
are not statistically significant
different from zero in both regression.
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GRANGER CAUSALITY TEST
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Two tests:
Granger causality test
Sim causality test
Case two stationary variables
Yt and Xt.
yt 10 11 yt 1 12 xt 1 1t form:
Standard/reduced
xt 20 21 yt 1 22 xt 1 2t
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GRANGER CAUSALITY
TEST
xdoes not G-cause y if xt 1 do not help
in prediction of y , controlling for all
t
other relevant information available at
t 1.
H 0 : x y( xdoes not G-cause y ) H 0 : 12 0
Single equation tests implemented as
Wald tests (F-statistic or 2 -statistic).
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GRANGER CAUSALITY
TEST
E-views implementation:
View/Lag Structure/Granger
causality-block exogeneity
tests (in VAR) or
Quick/Group
statistics/Granger causality
test/Series List/OK/Lag
Specification/OK
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GRANGER CAUSALITY
TEST
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GRANGER CAUSALITY
TEST
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