Time Series Models for Business and Economic Forecasting

Hung-Pin Lai March 18, 2007

The six key features of economic time series

Many time series data have at least one of the first five features: Trends Seasonality Somehow influential data points (aberrant observations) A variance that changes because of past observations (conditional heteroskedasticity) non-linearity Common features

1. Trends

Modeling trend
By a Linear trend

Use growth rate

Changing trends
1946-1960 increasing trend 1960-1973 decreasing trend 1974 -upward again

2. Seasonality
Observations in certain seasons display strikingly different features to those in other Seasons.

Modeling seasonality

(See figure 2.3 for the original data)

R2=0.296

R2=0.254

R2=0.965

R2=0.971

(increasing variance; changing seasonality)

(mean shift; regime shift; structural break)

television

radio

3. Aberrant observation
Definition: When a single observation have a major impact on time series modeling and forecasting, it is called aberrant observation.
yt =log(pricet)

Features of Figure 2.11:

1. The differenced yt is not a good approximation to the inflation when the quarterly inflation rate is high. 2. The data in 1989 (extreme value) seem to be quite different from those observations the years before. Consider the model:

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4. Conditional heteroskedasticity

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Aberrant observations tend to emerge in clusters Clusters of observations with large variances (volatility clustering or conditional heteroskedasticity) Modeling conditional heteroskedasticity:

5. Non-linearity
Everything other than nonlinearity Regime switching or state dependency

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Modeling regime switching:

Model

6. Common features
Common trend (cointegration); common seasonality, Multivariate models

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