Time Series and Panel Data Analysis

Problem Set #2
Due Date: October 18, end of the day
(Late submissions will get 0 points!)

Problem 1 (15 points)

Suppose, you have a sample of (Xt , Yt ) of size T = 506. You want to choose the
best possible model among VAR(p) for p = 0, 1, 2, 3, 4, and for that you decided
to use information criteria. How many observations will be used for the purpose
of this comparison? Fill in the missing values in the following table and choose
the best model:

Number of lags LogLikelihood # of parameters AIC BIC

0 −1404.02

1 −195.57

2 −139.94 299.694

3 268.57

4 340.86

Problem 2 (15 points)

Consider the VAR(2) model for (Xt , Yt ):

Xt = 1 + 0.25Xt−1 − 0.2Yt−1 + 0.05Yt−2 + ε1t

Yt = 2 + 0.4Xt−1 − 0.45Yt−1 + 0.18Xt−2 + ε2t

a) Re-write the model in the vector form. What are Θ1 and Θ2 ?

b) Is the process {(Xt , Yt )} stationary?

Problem 3 (15 points)

A regression of Yt onto current, past, and future values of Xt yields

Yt = 3 + 1.7Xt+1 + 0.8Xt − 0.2Xt−1 + ut .

Re-write this equation as the regression of Yt on Xt , ∆Xt , and lags and leads
of ∆Xt (i.e. like in the setting for the dynamic OLS).
a) What are the values of β0 , θ, δ1 , δ0 , and δ−1 ?

b) i) Suppose Xt is I(1) and ut is I(1). Are Yt and Xt cointegrated?

ii) Suppose Xt is I(0) and ut is I(1). Are Yt and Xt cointegrated?
iii) Suppose Xt is I(1) and ut is I(0). Are Yt and Xt cointegrated?

1
Problem 5 (15 points)
Consider the following model:

Yt = β0 + β1 Xt + ut ,

where ut follows a stationary AR(1) process ut = ϕut−1 + εt , where {εt } are

i.i.d. with mean 0 and variance σε2 , and Xt follows a stationary AR(1) process
Xt = γXt−1 + et , where et are i.i.d. with mean 0 and variance σe2 , and {et } and
{εt } are independent. You observe a sample {(Xt , Yt )}Tt=1 .

a) Define vt = Xt ut . Compute σv2 , the variance of vt .

b) Derive the expression for fT and f (the correction factors related to the
HAC variance estimator).

Problem 5 (40 points)

The HW2.xls data file contains daily (five days a week) Euro/U.S. Dollar spot
exchange rates and daily closing prices (trading days only) for the S&P 500 from
January 4, 1999 through December 31, 2011, for a total of 3,518 observations.
a) Calculate the first 50 autocorrelations for the daily logarithmic exchange
rates (i.e., ln(st )) and their first differences (i.e., rt = ln(st ) − ln(st−1 ).
Is the daily logarithmic exchange rate a stationary process? Be specific
about your choices of the test specifications. Is the series of the exchange
rate returns stationary? Perform the Ljung-Box test for 20, 40, and 60
lags of rt . What’s your conclusion? Following the Box-Jenkins procedure,
determine the most appropriate model for ln(st ). (Do not forget to per-
form the Ljung-Box test for the residuals of the chosen model). Report
the values of AIC and BIC for the candidate models.
b) Repeat the exercise for the daily logarithmic S&P500 prices.
c) Repeat the exercise for the absolute exchange rate returns (i.e., |rt | =
| ln(st ) − ln(st−1 )|) and the absolute S&P500 returns. How do the results
compare to those from before?
d) Do you expect the processes for log S&P 500 index and the log exchange
rates to be cointegrated? Perform the EG-ADF test. Be specific about
your choice of the test specification.
e) Is there any evidence that the exchange rate returns Granger-cause the
S&P500 returns? and vice versa?
f) Test for a break (with an unknown break date) in the logarithmic exchange
rates and log returns on S&P 500. Is there evidence for breaks? At which
dates? Repeat the analysis for the breaks in variances.