Unit roots and Granger causality in the EMS interest rates: The German Dominance Hypothesis revisited
Prodromidis, Kyprianos P.
SourceJournal of International Money and Finance
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The aim of this paper is twofold: First, it shows that: (a) sufficient conditions for unit roots, found in AR systems, to persist in VAR systems amount to Granger non-causality in any direction among the variables involved. This implies that a necessary condition for the disappearance of one unit root in a VAR system implies Granger causality in at least one direction(b) for first-order models with non-explosive variables, Granger causality is also sufficient for cointegrationand (c) causality and cointegration inference are strongly affected by the omission of an important causing variable. Second, our new analytical framework allows us to formulate and test several new variations of the so called German Dominance Hypothesis, in a unified cointegrating framework, which we define as Strong, Semi-Strong and Weak (types 1 and 2) German Dominance. In addition, we allow for the possibility that the dominant player may lie outside the EMS, so that we introduce and test the 'US Dominance Hypothesis'.