HOW TO RUN VECM (vector error correction model)

There are three steps to run VECM

1. Leg selection for the model, means how many lag must be select for our model.
2. Then co-integration, if we find co- integration than we can apply VECM otherwise
unrestricted VAR model.
3. VECM
STEP 1 LAG SELECTION
a.

Open all variable as group , as VAR

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b. Write the name of all variables and select lag 12 and ok like in above pic and following
results will be appear

Now from these

results go to view,
then lag structure,
then lag length

criteria.
c.
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d. From step (b) go to view of above results window, go to lag structure-lag length criteria and ok but
chose lag length what u like 3, 4 what u like where SIC or AIC IS MINIMUM THAT LAG LENTH IS
SUPERB OK (here you will find many criteria all are best but it depend on you what you like, for
example SIC, AIC etc.)

THIS WINDOW IS INDICATING

THAT LAG LENTH TWO IS GOOD
because if we add lag length
three then AIC AND SIC VLAUE
INCCRESE. And further most of
criterias are suggesting 2 is
optimal lag length, but if you are
making decision according to SC
1 is optimal

All are best criteria but choose lag lengths according to criteria
through you will make decision. Like if I am making final decision
according to FPE then 2 is optimal lag lengths.

So one more thing if AIC suggest

8 lags, while SIC suggest 3 lags it
depend on you what you

like both are true

e.
STEP TWO JOHNSON CO-INTEGRESSION TEST
FROM above result we have decided that lag length two is good)
Step 2.1 go to quickgroup statistic Johnson co-integration remember for co-integration chose lag
length which we decide in first step on lag length selection and ok and one thing more used current
results output for the test if u use new window or then results may suffer losses,

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Here I see six is suitable lag length, so

next step is to find out that either there is
cointegration or not between
variables.so I go to quick of resulted
window, the Johnson cointegration.

Explanation of this dialog box

Deterministic trend assumption of test Practical guides:
use case 1 only if you know that all series have zero mean (unusual in empirical studies);
case 5 may provide a good fit in-sample but will produce implausible forecasts out-of-sample.;
use case 2 if none of the series appear to have a trend;
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 use case 3 if series are trending and you believe all trends are stochastic;
use case 4 if series are trending and you believe some of them are trend stationary;
use case 6 if you are not certain which trend assumption to use (Eviews will help you determine
the choice of the trend assumption).

Here we find that there are two cointegration

equations in our model which is good for us
Note: to conclude that there is cointegration exist or
not only one cointegration equation is enough,
Note :some time trace test indicate cointegration
,while maximum Eigen test indicate no cointegration
this case you can conclude that there is cointegration
among variable on the base of trace test as bench
mark, same if trace showing no cointegration while
maximum Eigen showing cointegration you can say
there is cointegression .
Note its better if both of test showing same results.
Condition fulfill of cointegration for VECM now we can
move ahead.

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Now we have applied co-integression if we find co-integression the apply VECM and if u did not find cointegration then apply U-VAR model
Another example of cointegression having only one
cointegration equation.

We find that there is one co-integrated

equation which means their is a long run
relation between variables, means all these
variables move together,

Note; for the co-integration minimum one

equation must be co- integrated, not
necessary that at most, 1 or two or three are
co- integrated.
Note: if we find no cointegration we must
apply unrestricted var model

Step three VECM

Now we have found that there is a long run relation in our variables means our variables are cointegrated.
From above output file we will go quickestimation of varAnd here ill select vector error correction then ill write first dependent variable and the all independent
variables like co2 oil gdp and I must select lag length which a selected from our first step minimum AIC
and SIC which was two and last thing in the present window go to co-integression option select the cointegrated equation like in our above Johnson test we have find only one equation which was cointegrated so we will chose 1. And ok
Note vecm will tells us about the causality between variables
Step2

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when click ok this window will be open

here if see there is no P value so to find out
p value we go to procmake system by
variable and ok

From above windows go to procsystem- variable ok and a window will be open like this

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Now u must copy the only one equation (D(CO2) = C(1)*( CO2(-1) - 0.002313245974*OIL(-1) 0.0002037688597*GDP(-1) + 0.3834446834 ) + C(2)*D(CO2(-1)) + C(3)*D(CO2(-2)) + C(4)*D(OIL(-1)) +
C(5)*D(OIL(-2)) + C(6)*D(GDP(-1)) + C(7)*D(GDP(-2)) + C(8))the above equation and go to quick and
estimate equation and past and ok

From here we will choose either here long run

causality or not
Long run causality: note: c(1) if comes negative
and significant we can say there is long run
causality running form oil and gdp to co2 , but in
our case c(!) value is not negative and significant
so we can say there is no long run causality
Short run causality: now we will check short run
causality with the help of Wald test.

How to check short run causality

Now we will apply Wald test, so how to test Wald test? first of all we will decide that from which
independent variable we are going to check causality with dependent variable like in the following
example Im going to check short run causality between oil and co2.we go to view coefficient
diagnostic Wald

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So we want to check
causality between oil
and co2 ,c(4)=c(5)=0

Now question is that how we decided c(4) and c(5) representing oil. So look below and remember above
generated equation. Here c(6) is gdp thats why i did not include c(6) in oil

equation (D(CO2) = C(1)*( CO2(-1) - 0.002313245974*OIL(-1) 0.0002037688597*GDP(-1) + 0.3834446834 ) + C(2)*D(CO2(-1)) + C(3)*D(CO2(-2)) +

C(4)*D(OIL(-1)) + C(5)*D(OIL(-2)) + C(6)*D(GDP(-1)) + C(7)*D(GDP(-2)) + C(8))

Now go view coefficient diagnostic Wald and past c(4)=c(5)=0 and ok if chi- square probability value
comes more the 5% percent we will accept null hypothesis means no causality,but here we will reject
null hyposthes and say there is cusality

And same for other variables

1. Further u can check serial correlation and other diagnostic test.
Thank you so much for being we with and sir sayed Hossain .
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From this window check serial correlation and other diagnostic test.

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