A Simple Test for Causality in Volatility

Chia-Lin Chang () and Michael McAleer

No EI2016-40, Econometric Institute Research Papers from Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute

Abstract: An early development in testing for causality (technically, Granger non-causality) in the conditional variance (or volatility) associated with financial returns, was the portmanteau statistic for non-causality in variance of Cheng and Ng (1996). A subsequent development was the Lagrange Multiplier (LM) test of non-causality in the conditional variance by Hafner and Herwartz (2006), who provided simulations results to show that their LM test was more powerful than the portmanteau statistic. While the LM test for causality proposed by Hafner and Herwartz (2006) is an interesting and useful development, it is nonetheless arbitrary. In particular, the specification on which the LM test is based does not rely on an underlying stochastic process, so that the alternative hypothesis is also arbitrary, which can affect the power of the test. The purpose of the paper is to derive a simple test for causality in volatility that provides regularity conditions arising from the underlying stochastic process, namely a random coefficient autoregressive process, and for which the (quasi-) maximum likelihood estimates have valid asymptotic properties. The simple test is intuitively appealing as it is based on an underlying stochastic process, is sympathetic to Granger’s (1969, 1988) notion of time series predictability, is easy to implement, and has a regularity condition that is not available in the LM test.

Keywords: Random coefficient stochastic process; Simple test; Granger non-causality; Regularity conditions; Asymptotic properties; Conditional volatility (search for similar items in EconPapers)
JEL-codes: C22 C32 C52 C58 (search for similar items in EconPapers)
Pages: 9
Date: 2016-11-01
New Economics Papers: this item is included in nep-ets and nep-ore
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: A Simple Test for Causality in Volatility (2017)
Working Paper: A Simple Test for Causality in Volatility (2016)
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