Professor Clive Granger, winner of 2003 Nobel Prize in economics, passed away on May 27, 2009. Few will argue that he revolutionized the field of economic time series forecasting. Professor Granger was particularly interested in prices and applied his theoretical ideas of causality and co-integration to financial stock market price time series.
He questioned bad econometric practices when he saw them….
“Before Dr. Granger’s studies, it was common practice for economists to take methods intended for stationary time series and use them to analyze nonstationary ones. But Dr. Granger — working closely with a colleague at the University of California at San Diego, Robert F. Engle — demonstrated that this approach could produce erroneous results” (http://www.nytimes.com/2009/05/31/business/31granger.html).
…and determined theoretically-sound concepts to overcome the underlying challenges.
“For want of better techniques, economists often applied statistics designed for stationary data to non-stationary data. But in 1974, Granger and his post-doctoral student Paul Newbold, building on the earlier work of the British statistician G Udny Yule, showed that pairs of non-stationary time series could frequently display highly significant correlations when there was no causal connection between them. For example, the US federal debt and the number of deaths due to Aids between 1981 and 2000 are highly correlated but are clearly not causally connected. Such “nonsense correlations” called into question the meaningfulness of many econometric studies.” (http://www.telegraph.co.uk/news/obituaries/finance-obituaries/5407598/Professor-Sir-Clive-Granger.html).
Professor Granger was awarded Nobel Prize in 2003 for his foundational work in the area of co-integration.
“His innovation has completely changed the way that economists estimate and build dynamic models of the macro economy,” Torsten Persson, an economist at the University of Stockholm who served on the Nobel Prize Committee for Economic Sciences, said at a ceremony honoring Dr. Granger in 2003. “Nowadays co-integration methods are literally used everywhere — by academically minded researchers in universities, as well as more practically minded investigators, be it in central banks or the private sector” (http://www.nytimes.com/2009/05/31/business/31granger.html).
As practitioners in the field of pricing, we owe a lot to Professor Granger and his lifetime of dedicated work.