Economics 174

Quiz 2
March 14, 2012
1. Consider the model:
1
t
= c +,1
t1
+
t

t
\`(0. o
2
) and j1 +,j < 1
(a) Find the mean and variance of 1
t
.
(b) Find the rst two autocovariances of 1
t
.
(c) Find the rst two autocorrelations of 1
t
.
2. Consider the standard 1(1) : 1
t
= ,
0
+ ,
1
1
t1
+ n
t
, where the usual assumptions
hold.
(a) Show that
t
= ,
0
1
t1
+ n
t
, where
t
is 1
t
with the mean removed, i.e.,
t
=
1
t
1(1
t
). What is 1(
t
)?
(b) Show that the :period ahead forecast 1

T+vjT

= ,
v
1

T
. If 0 < ,
1
< 1, how
does the :period ahead forecast behave as : becomes large?
What is the forecast of 1
T+vjT
for large :?
(c) The median lag is the number of periods it takes a time series with zero mean to
halve its current value (in expectation), i.e., the solution : to
1

T+vjT

= 0.5
T
. Show that in the present case this is given by : =
log(2)
log(o
1
)
.
3. You run the following regression to model Canadian ination (1:,C
t
), from 1962 :
1 1999 : 1\ , where the numbers in parenthesis are the corresponding standard
errors:
1:,C
1ittco
t
= 0.49
(0.28)
0.10
(0.05)
1:,C
t1
0.39
(0.09)
1:,C
t1
0.33
(0.09)
1:,C
t2
0.21
(0.09)
1:,C
t3
+ 0.05
(0.08)
1:,C
t4
1
Test the presence of a stochastic trend.
(b) To forecast the Canadian ination rate for 2000 : 1, you estimate an AR(1), AR(4)
and an ADL(4,1) model for the sample period, 1962 : 1 1999 : 1\ . The results are:
1:,C
1ittco
t
= 0.002
(0.014)
0.31
(0.10)
1:,C
t1
1:,C
1ittco
t
= 0.021
(0.158)
0.46
(0.10)
1:,C
t1
0.39
(0.11)
1:,C
t2
0.25
(0.08)
1:,C
t3
+0.03
(0.08)
1:,C
t4
1:,C
1ittco
t
= 1.279
(0.57)
0.51
(0.10)
1:,C
t1
0.44
(0.11)
1:,C
t2
0.30
(0.09)
1:,C
t3
0.02
(0.08)
1:,C
t4
0.16
(0.07)
l:ctcC
t1
where l:ctcC
t
is the unemployment rate in time t.
In addition, you have the following information on ination in Canada during the four
quarters of 1999 and the rst quarter of 2000 :
Quarter l:ctcC
t
1:,C
t
1:,C
t1
1999 : 1 7.7 0.8 0.8
1999 : 11 7.9 4.3 ?
1999 : 111 7.7 2.9 ?
1999 : 1\ 7.0 1.3 ?
2000 : 1 6.8 2.1 ?
For each of the three models, calculate the predicted ination rate for the period
2000 : 1, and the forecast error.
(c) Perform a test on whether or not Canadian unemployment rates Granger-cause
the Canadian ination rate.
4. Consider the following distributed lag model:
1
t
= ,
0
+,
1
A
t
+,
2
A
t1
+n
t
;
where n
t
= c
1
n
t1
+i
t
Here i
t
is white noise, and A is strictly exogenous.
2
(a) How many parameters are there to be estimated between the two equations?
(b) Using the two equations of the model above, derive the ADL form of the model.
5. Suppose that 1
t
follows a stationary AR(1) model: 1
t
= ,
0
+,
1
1
t1
+n
t
.
(a) What is the /period ahead forecast of 1
t
? Write it in terms of j
Y
=
o
0
1o
1
(b) Suppose that A
t
is related to 1
t
by A
t
=
P
1
i=0
o
i
1
t+ijt
where joj < 1. Show that
A
t
=
j
Y
1c
+
Ytj
Y
1o
1
c
6. Consider a two variable \ 1 :

t
= ,
11

t1
+
11
r
t1
+n
1t
r
t
= ,
21

t1
+
21
r
t1
+n
2t
Show that the iterated two period ahead forecast for can be written as
tjt2
=
o
1

t2
+ o
2
r
t2
and derive the values for o
1
and o
2
in terms of the coecients in the
VAR.
7. The following question uses the concept of cointegration: Suppose that A
t
and 1
t
are
integrated of order one (that is, both A
t
and 1
t
have unit roots). Then, if for some
coecient o, 1
t
oA
t
is integrated of order zero (does not have a unit root), then A
t
and 1
t
are said to be cointegrated. The coecient o is the cointegrating coecient.
If A
t
and 1
t
are cointegrated, then they have the same, or common, stochastic trend.
Computing the dierence 1
t
oA
t
eliminates this common stochastic trend.
For two variables A
t
and 1
t
, suppose 1
t
=
1
I
P
I1
i=0
A
t+ijt
+c
t
. Suppose that A
t
follows
a random walk, so that A
t
= A
t1
+n
t
(c
t
and n
t
are white noise)
(a) Show that 1
t
= A
t
+c
t
.
For the following parts, the following information will be useful - 1
t
and A
t
are cointe-
grated since 1
t
A
t
= c
t
, and c
t
is a white noise. The cointegrating coecient in this
case is 1.
(b) Suppose that A
t
= 0.5A
t1
+n
t
. What is the cointegrating coecient between
A
t
and 1
t
in this case?
3
(c) Now suppose A
t
= 0.5A
t1
+n
t
. What is the cointegrating coecient between A
t
and 1
t
now?
8. For the following regressions (t-statistics in brackets):
^
t
= 1
(8.05)
+ 3
(4.14)
r
1t
; 1
2
= 0.79
^
t
= 1.4
(3.04)
+ 2.8
(5.21)
r
1t
+ 3.4
(3.01)
r
1t
; 1
2
= 0.89
What is the sample size?
4