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ABSTRACT:
A variable is defined to be self-generating if it can be forecast efficiently from its own past only. Conditions are derived for certain linear combinations to be self-generating in error correction models. Interestingly, there are only two candidates for self-generation in an error correction model. They are cointegrating relationships and common stochastic trends defined by Gonzalo and Granger (1995). The usefulness of self-generation as a multivariate-modelling tool is investigated. A simple testing procedure is also presented. Some interesting economic hypothesis can be easily tested in the self-generation framework. For example, for forward exchange rate to have forecasting power for the future movements in spot rate, the latter should not be self-generating. Given that they are cointegrated, the spot exchange rate should not be a common stochastic trend, which can be easily tested. We also provide additional examples.

SUGGESTED CITATION:
Clive W.J. Granger and GAWON YOON, "Self-Generating Variables in a Cointegrated VAR Framework" (February 20, 2001). Department of Economics, UCSD. Paper 2001-04.
http://repositories.cdlib.org/ucsdecon/2001-04