short term and long term dynamics model

Vector Error Correction Model Configuration & Analysis

Relational econometric model for time-series data

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Error correction model (ECM)is important in time-series analysis to better understand long-run dynamics. ECM can be derived from auto-regressive distributed lag model as long as there is a cointegration relationship between variables. In that context, each equation in the vector auto regressive (VAR) model is an autoregressive distributed lag model; therefore, it can be considered that the vector error correction model (VECM) is a VAR model with cointegration constraints.

Cointegration relations built into the specification so that it restricts the long-run behavior of the endogenous variables to converge to their cointegrating relationships while allowing for short-run adjustment dynamics. This is known as the error correction term since the deviation from long-run equilibrium is corrected gradually through a series of partial short-run adjustments.

The above theory would be clear once we run through an example and a use case. Let us collect some data sample.