1

Aneesha Chandra
ECO 3402-1
18 March 2021
Assignment 2
Q4.
a. The logarithmic change in the PPI is formed and stored in the variable dly.
The output results for each model are tabulated below:
AR (1, 3)

AIC BIC criteria:

ACF of the residuals:

 2

ARMA (1,1)

AIC-BIC criteria:
 3

The ACF of the residuals:

AR (3)

AIC-BIC criteria:
 4

The ACF of the residuals:

The lowest AIC is for AR(3). The lowest BIC is for ARIMA(1,1).
(b) We use the remaining observations for out-of-sample and employ the DM test.

The DM test tells us that ARMA(1,1) gives the better forecasts as compared to AR(1,3).
 5

(c) The problem in comparing the out-of-sample fit of AR (1, 3) to AR (3) is that this is an
instance of a nested model. The larger model loses observations as compared to the nested
model. As a result, it is more likely to contain errors.
(d)
AR (5)

AIC BIC:

ACF of the residuals:

 6

ARMA (2, 1)

AIC BIC criterion:

 7

ACF of the residuals:

AIC is lower for AR(5) as compared to ARMA(2,1). BIC is lower for ARMA(2,1) as compared
to AR(5). Considering the residuals, ARMA(2,1) is preferred over AR(5) in this case.