Queen Mary, University London Liudas Giraitis Time Series Analysis Solutions: Problem Set 4 Problem 1. Consider AR(2) model Yi=01+0.2¥i1 -0.1%2 +e where ¢ is a white noise sequence with zero mean and variance 1 (1) Find the 1-step ahead forecast of Yin (2) Find the 2-step ahead forecast of Yis2 (3) Find the variance of the 1-step ahead forecast and the variance of 2step ahead forecast. Compare these variances. (4) Find the 3-step ahead forescast. Solution 1. If we have AR(2) model. Ye = bo + b1Yi-n + b2Yia + Et The k-step ahead forecast is defined by the formula Yi(h) = ElYesel Fl) (1) To compute Y;(1) first we write Yinr = bo + OY, + PaYia + etn Then Yl) = BlYesalFi] = Eldo + 1%. + b2Yea + &41|F] got hEMF] + 2b MalF] + Blew lA} = dot hYitdo¥in. Here we used the facts EMIAI=%, EMAalh] =Yia 1which hold because ¥; and Y;-; are known when we know F,, and Bleual) = which is valid because ¢,,4 is independent of the ‘history F.. ‘Therefore, since by = 0.1, 41 = 0.2, 43 = -0.1, the 1-step ahead forecast is ¥,(1) = 0.1 + 0.2%, - 0.1%. (2) To compute 2-step ahead forecast, write Visa = bo + drYisa + b2¥%e + Eta. ‘Then Yi(2) = ElYisalFi] = Bldo + bier + bY + ees2l Fi] 0+ bE MualF) + EMF e+ d:¥i(1) + daY¥.. We found that . (1) = 0.1 40.2% - 0.1%. So, keeping in mind that ¢) = 0.1 and $1 = 0.2, ¥{(2) = 0.1+0.2(0.1+0.2¥ — 0.1%1) + (-0.1)%i1 = 0.12 + 0.04Y; - 0.12¥, (3) The error of 1-step ahead forecast is ae(l) = Yan - Yi) Go + bY: + bain + er41 — (bo + 1% + bo¥i-1) = eu ‘The variance of the error is Var(ex(1)) = Var(ees1) = 2‘The error of 2-step ahead forecast is er(2) = Yera - Y4(2) ; = bot dsYins + ba¥i + e102 ~ (0 + d1%i(L) + 0%) = gi(Yen — Yi(1)) + etna = The variance of the error is Var(ex(2)) = Var(drerss + tsa) = Var(drerss) + Var(er42) = dj? +0? = (0.2)? +1= 1.04. neta + E42: We conclude that Var(ex(2)) > Var(ex(1)) (4) To compute 3-step ahead forecast, write Yrs = bo + brYiee + b2¥isi + £143 ‘Then El¥i4s|Fi] = Elbo + d1Yine + b2¥igs + €e|F] bo + GE Mi2\Fi] + b22[Yir1\F] = dot dr¥i(2) + bYi(l). We found that ¥.(1) =0.1+0.2¥; 0.1%, ¥%4(2) = 0.12 — 0.06Y; — 0.02%, So, keeping in mind that @ = 0.1 and ¢1 = 0.2, ¥,(3) 0.1 + 0.2(0.12 + 0.04Y;, — 0.12%.) + (—0.1)(0.1 + 0.2%, — 0.1%) = 0.1 + 0.024 + 0.008Y; — 0.024Y;_1 + [-0.01 — 0.02¥, + 0.01%,-1] = 0.124 — 0.012¥, — 0.14%. 1. Problem 2, Obtain the mean, variance and lag-1 autocorrelation of the MA(1) series Y= eet Oe where e is an ii.d. (0, 02) sequence. Show that the higher order autocorrelations p,, k > 2 are equal to zero.Solution 2 (a) First we compute the mean E[Y) = Elec + 0ee-1] = Flee] + 9Fle,-1] = 0+ 0(0) =0. Var(¥%) = Bl(% — B(Y4))"] = Eller + Gee1)] = Ble} + 2ere4-1 + Pe? 2] = Ele] +26B|evera) + 6*B leo] a2 + 20(0) + #02 o2(1 +6"), (b) To find the autocovariance at lag-1 note, that by definition, for k > 1, Coulis Yi-e) = El(¥i - B[Y))(%-+ - BI%4))] = BMY a] = Bl(ee+ Oe-a)(E-n + 6ee-r-1)] Elevee-n + O€tr€1-& + eee ea + OPE 16e-ea] Blevee—n] + OB erre1—4] + OB ecer-n—1] + O Blerrer-n1]. ‘Therefore the lag-1 auto-covariance is oh = Blever1] + OE[e,-161-1] + 0B lece-o) + 6°Bler161-2] = 04002 +0+0= 602, ‘The autocorrelation at lag 1 is n a) Pe Cole) = Farle = BLP TA) (c) If k > 2, then te = Berea] + OF er-161-4) + OF (ec+-na] + P Ble aerna] = 0 because € is a white noise, and therefore Elee,] = 0 if t # s. Then the autocorrelation =%_2 == 0%Problem 3. Consider the MA(1) time series Yi = 6 — 0.81, where ¢ is a white noise sequence with zero mean and variance 1. (a) Find B[%], [Ys], Var(%4) and Var(¥o) (b) Find the covariance of ¥; and Yo, and the covariance of ¥2 and Ys. (c) What is the mean and the variance of Yiqo? Solution 3. Write Ye et Oe, where 0 = -0.8, 02 = 1. (a) ¥; is a stationary MA(1) n time series. We have E(Y] = Ele, — 0.81] = Bled] — 0.8E le ‘Therefore EM] = B[%s] = 0. In 2a) we showed that Var(¥,) = o3(1 + 6°) = 1(1 + (0, 8)?) =1+0.64 = 1.64. ‘Therefore Var(¥%) = Var(¥2) = 1.64. (b) In problem 2b) we showed that n= Coul, ¥i-1) = 802 = (-0.8)1 0.8, and = Cov(¥i, Ye) Because of symmetry property, for k=2,3,... Cov(Ya, Ys) = Cov(Ya, Ya) = 71 = -0.8.(c) Since ¥; is a stationary time series, then the mean £[Y;] and the variance Var(Y,) are constant. Therefore E[¥i00] = Var(Y;o0) = 1.64 Problem 4, Work out the autocorrelation function p; for each of the fol- lowing models: (a) Ye = & ~ 0.5e15 (b) ¥ - 0.8% =e where ¢, is a white noise sequence with zero mean and variance 2. Solution 4, (a) We have to find 7 = Cou(%, Yi-s). By definition 4 = BUY ~ EY))(Yi-s — EMM-s)))- Since Y= 6 - 0.561 then BY) = Ele) — 0.5Ele1] =0 because Ele;] = Ele.1] = 0. Therefore ay = ELV -3) = Eller — 0.5¢r-1)(€r- — 0.5e1-4)] = Elevers — 0.5e-164-3 — €10.5e¢-4 + 0.5e;-10.5e.-4] = Elecee—s] — 0.5E[e+—1€+-3] — 0.5E [ever] + (0.5)°Bleraer since ¢; is a white noise and therefore Elee]=0 if t#s. ‘Thus the autocorrelation 2 _ 0 =Bal =o On (b) We have that Ye - 08% =e 6First note that this model can be written as AR(1) model Y= ate with p = 0.8. Since |p| < 1, the model is stationary, so the mean E[Y;) = is constant. We show that EY] = 0, That follows taking the expectation of ¥; — 0.8Y;-1 = ¢: which implies that E [| - 0.881%] = Bled. Since Ble,] = 0 and E[Y,] = E[Y-1 1, we see that 1-08 =0 and therefore 0.24 = 0, so that j= 0. ‘Therefore autocovariance Ye = Cov(¥i, ¥en) = E[(Yi - ELV) (Vi-e — B[M-a))] = BI Y.-4]- To find 1, we multiply both sides of the equation Y; — 0.8Y;-1 = €: by Yi-«: YY — 0.8% aN = Yen ‘Then YYi-k = O.8Yi Yin + Vik ‘Taking expectation of both sides we obtain EYY,-4] = 08E(% AY +] + BleY.-n]- Since for k > 1, we have Elec¥:_x] = 0, and y = E[¥:¥;_»] we see that Ne = 0.8 %-1, So, ‘7 = 0.8472 = (0.8)’n = (0.8)"10 By definition, ps = Corr(Yi, ¥i-a)Problem 5. Show that the two MA(1) processes X= e+ Oe Y= net m1 have the same autocorrelation function. Here ( WN(0, 02) are white noise sequences. ) ~ WN(0,02) and (nm) ~ Solution 5. (a) Consider MA(1) time series Xp =e: + 021-1 Solving Problem 2a) we showed that 0 = Var(X;) = 02(1 +82). In Problem 2(b) we showed that 71 = Cov(Xe, Xi-2) = 028, and therefore (y-B- 2? 8 Px) = = LO) T+ In Problem 2c) we showed that =Cov(Xi,Xi4)=0, for k and therefore px(k)=0, for k=2,3,.. (b) Consider now MA(1) time series ¥; = me + bear Note that (¥;) can be written in the same form as X,: Y= m+ Om1 with parameter 6” = }. ‘Therefore for ¥; we can apply the results of part (a) py (1) Section a) implies that pr(k) =0=px(k), for k=2,3,.. Therefore py(k) = px(k), for k=0,1,2,3,...,aly = mw 6. Using the following EVIEWS output, determine the order q of an MA(q) model you would fit to the data. AC PAC Q-Stat Prob — 3.0385 0.057 10.303 0.008 0.081 0070 15296 0.002 070 0.063 19.000 0.001 0.080 0.031 20.934 0.001 0.088 0.038 23.488 0.001 0.059 v.39 26.123 0.000 a.016 -0.008 26.303 oot 0,086 0.048 2.843 0.001 0,043 0.024 31.077 0.001 O77 0.001 0.002 Solution 6: Selecting the order of MA(q) model, we test the hypothesis Ao: pe = 0 against alternative Hi: py #0 at lags k = 1,2,... at significance level 5%, where py is ACF function. ACF px at lag k is significant, if |f,| > 2/VN, where N is the number of observations. Tf |x| < 2/VN, then ACF at lag k is not significantly different from 0. We select for q the largest lag at which the ACF is significant. This rule can be used becauise the ACF of the MA(q) model becomes 0 for lags k > g. We have 2//N = 2 = 2/755 = 0.0727. The ACF is significant only at the lag 2 and 3. Hence we would fit MA(3) model. AACE 0 0e2h ——— _ — + 2 4 is A