The following charts show the monthly S&P 500 index and the FTSE 100 index over approximately the last ten years.

The two indices relate to the USA and the UK, respectively.Both indices are I(1).

a)Given that the two series are I (1), is it possible for there to be a causal relationship between them?If it is possible, how would you test for the existence of such a relationship?[5 marks]

b)Suppose that we then estimated the following pair of regressions: [1]

and

where numbers in ( ) are the standard errors of the estimated coefficients. f represents the FTSE100 index and s represents the S&P 500 index.

The residuals from regression

(2) do not exhibit serial correlation or heteroskedasticity.

Given these results, what can be said about the relationship between the two indices?[35 marks]