Seminar 5.

Vector autoregression models

Definition (VAR model): set of linear dynamic equations where each variable
is specified as a function of an equal number of lags of itself and all other variables
in system.

To specify a VAR in EViews, you must first create a var object. Select
Quick/Estimate VAR... or type var in the command window. The Basics tab of
the VAR Specification dialog will prompt you to define the structure of your VAR.
You should fill out the dialog with the appropriate information:
• Select the VAR type: Unrestricted VAR.
• Set the estimation sample.
• Enter the lag specification in the appropriate edit box. This information is entered
in pairs: each pair of numbers defines a range of lags.
• Enter the names of endogenous and exogenous series in the edit boxes.

The rest dialog tabs (Cointegration and Restrictions) are important only for VEC
models.

VAR Estimation Output

After you have specified the VAR => OK.

EViews will display the estimation results in the VAR window.

 Each column in the table
corresponds to an equation in the
VAR.
For each right-hand side variable,
EViews reports the estimated
coefficient, its standard error, and
the t-statistic. For example, the
coefficient for shiller(-1) in the
sp500 equation is -0.6052
EViews displays additional
information below the coefficient
summary. The first part of the
additional output presents standard
OLS regression statistics for
each equation. The results are
computed separately for each
equation using the appropriate
residuals and are displayed in the
corresponding column.
The numbers at the very bottom of
the table are the summary statistics
for the VAR system
as a whole.

Problem set:

1. Make a model of the VAR

2. Try to interpret the results
3. Can all the cointegrated systems be represented as an error-correction
model? What are the problem/s of analyzing a VAR in the differences when the
system is cointegrated?
4. Consider the following VAR
yt  (1   ) yt 1  xt 1   1t
xt  yt 1  (1   ) xt 1   2t

(a) Show that this VAR is not-stationary.

(b) Find the cointegrating vector and derive the VECM representation.
 (c) Transform the model so that it involves the error correction term (call
it z) and a difference stationary variable (call it wt). w will be a linear
combination of x and y but should not contain z. Hint: the weights in
this linear combination will be related the coefficients of the error
correction terms.
(d) Verify that y and x can be expressed as a linear combination of w and
z. Give an interpretation as a decomposition of the vector (y x)’ into
permanent and transitory components.

PR3: «VAR model–the impact of a macroeconomic policy on inflation and

economic activity» Katarzyna Lada, Piotr Wójcik

Literature
Required

Brooks C. Introductory Econometrics for Finance. Cambridge University Press.

2008.
Cuthbertson K., Nitzsche D. Quantitative Financial Economics. Wiley. 2004.
Tsay R.S. Analysis of Financial Time Series, Wiley, 2005.
Y. Ait-Sahalia, L. P. Hansen. Handbook of Financial Econometrics: Tools and
Techniques. Vol. 1, 1st Edition. 2010.

Recommended
Alexander C. Market Models: A Guide to Financial Data Analysis. Wiley. 2001.
Cameron A. and Trivedi P.. Microeconometrics. Methods and Applications. 2005.
Lai T. L., Xing H. Statistical Models and Methods for Financial Markets. Springer.
2008.
Poon S-H. A practical guide for forecasting financial market volatility. Wiley,
2005.
Rachev S.T. et al. Financial Econometrics: From Basics to Advanced Modeling
Techniques, Wiley, 2007.