Time Series Analysis Final Exam Kaiji Motegi

Fall 2016 Solutions Kobe University

Problem-1: In Assignment 1 we discussed a covariance stationary ARMA(1,1):

yt = yt1 + t + t1 , (1)

where || < 1 and {t } is white noise with E[2t ] = 2 . We found that the population
moments are given by

E[yt ] = 0, (2)
1 + + ( + )
0 E[yt2 ] = 2 , (3)
1 2
( + )(1 + ) h1
h E[yt yth ] = 2 for h 1, (4)
1 2
h ( + )(1 + ) h1
h = for h 1. (5)
0 1 + + ( + )

In this problem we slightly generalize Eq. (1) by adding an intercept c:

xt = c + xt1 + t + t1 , (6)

where || < 1 and {t } is white noise with E[2t ] = 2 . Let us compute the population
moments of {xt }.

(a) Show that Eq. (6) can be rewritten as Eq. (1) with yt = xt x and x = c/(1 ).

(b) Show that E[xt ] = x . (Hint: Use Eq. (2).)

(c) Show that x,0 E[(xt x )2 ] = 0 . (Hint: Use Eq. (3).)

(d) Show that x,h E[(xt x )(xth x )] = h for h 1. (Hint: Use Eq. (4).)

(e) Show that x,h x,h /x,0 = h for h 1. (Hint: Use Eq. (5).) (Remark: We have
essentially shown that adding an intercept only shits the mean and does not change

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

the variance, autocovariance, or autocorrelation.)

Solution-1: (a) Let x = c/(1 ) so that c = (1 )x . Then Eq. (6) can be rewritten as

xt = (1 )x + xt1 + t + t1 .

Rearrange this to get

xt x = (xt1 x ) + t + t1 .

Hence we get Eq. (1) by redefining yt = xt x .

(b) Since E[yt ] = E[xt x ] = E[xt ] x = 0, we have that E[xt ] = x .

(c) x,0 E[(xt x )2 ] = E[yt2 ] = 0 .

(d) x,h E[(xth x )2 ] = E[yth

2
] = h .

(e) x,h x,h /x,0 = h /0 = h .

Problem-2: Consider GARCH(1,1):

yt = t , (7)
i.i.d.
t = t t , t (0, 1), (8)

t2 = + 2t1 + t1
2
, w > 0, 0, 0, + < 1. (9)

Assume that E[t4 ] < and 1 2 + 2 + 2 < 1. In the midterm exam, we

showed that {2t } follows ARMA(1,1) with a positive intercept:

2t = + ( + )2t1 + t t1 , (10)

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

where {t } is a martingale dierence sequence that has finite variance

0 ( 1)
2 E[t2 ] = <
1 1

with
2 (1 + + )
0 = and 1 = 2 + 2 + 2 .
1

In this problem we compute population moments of {2t }. (Hint: Throughout the problem,
exploit the results from Problem-1.)

(a) Compute 2 E[2t ].

(b) Compute 2 ,0 E[(2t 2 )2 ]. (Instruction: Your final expression can depend on 2 .)

(c) Compute 2 ,h E[(2t 2 )(2th 2 )] for h 1. (Instruction: Your final expression

can depend on 2 .)

(d) Compute 2 ,h h /0 for h 1.

(e) Consider the following parameterizations:

Case 1. = 3, = 0.2, and = 0.5.

Case 2. = 3, = 0.5, and = 0.2.

Calculate 1 , 2 ,1 , 2 ,2 , 2 ,3 , 2 ,4 , and 2 ,5 for each case. (Remark: For each case

1 < 1 so that 2 ,h is well defined for any h 1.)

(f) In which case {2t } is more persistent, Case 1 or 2? Write a brief reason for your answer.

Solution-2: (a) Since {t } is white noise, Eq. (10) is a well-defined ARMA(1,1) with respect
to {2t }. Eq. (10) can be interpreted as a specific case of Eq. (6) with intercept c = , AR

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

Table 1: Examples of GARCH

1 2 ,1 2 ,2 2 ,3 2 ,4 2 ,5
Case 1 3 0.2 0.5 0.57 0.236 0.165 0.116 0.081 0.057
Case 2 3 0.5 0.2 0.99 0.566 0.396 0.277 0.194 0.136

coecient = + , MA coecient = , and error variance 2 = 2 . Substitute these

quantities into x = c/(1 ) to get 2 = /[1 ( + )] = /(1 ).

(b) We have from Eq. (3) that

1 + ( + )() + ()[( + ) + ()]

2 ,0 = 2
1 ( + )2
(1 2 2 )2
= .
(1 + + )(1 )

(c) We have from Eq. (4) that

[() + ( + )][1 + ()( + )]

2 ,h = 2 ( + )h1
1 ( + ) 2

(1 2 )2
= ( + )h1 .
(1 + + )(1 )

(d) We have from Eq. (5) that

[() + ( + )][1 + ( + )()]

2 ,h = ( + )h1
1 + ( + )() + ()[( + ) + ()]
(1 2 )
= ( + )h1 .
1 2 2

(Remark: The autocorrelation of {2t } decays at rate + .)

(e) See Table 1.
(f) {2t } is more persistent in Case 2 than in Case 1 since 2 ,h is uniformly larger for all
lags h 1 (cf. Table 1).

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

Problem-3: Consider random walk with drift and noise:

yt = c + yt1 + t + t , (11)

where {t } is white noise with E[2t ] = 2 ; t = t t1 ; {t } is white noise with E[t2 ] = 2 ;

E[t s ] = 0 for any t and s; y0 and 0 are non-stochastic initial values.

t
(a) Show that yt = ct + y0 + j=1 j + t .

(b) Show that E[yt ] = ct + y0 .

(c) Show that V ar[yt ] E[(yt E[yt ])2 ] = 2 t + 2 .

(d) Show that Cov[yt , yth ] E[(yt E[yt ])(yth E[yth ])] = 2 (t h) for h 1.

(e) Is {yt } covariance stationary? Explain why or why not.

Solution-3: (a) We have that

yt = c + yt1 + t + t

= c + (c + yt2 + t1 + t1 ) + t + t

= 2c + yt2 + (t + t1 ) + (t + t1 )
(12)
= 3c + yt3 + (t + t1 + t2 ) + (t + t1 + t2 )

= = ct + y0 + (t + t1 + + 1 ) + (t + t1 + + 1 )

t
= ct + y0 + j + t .
j=1

t
(b) E[yt ] = E[ct + y0 + j=1 j
+ t ] = ct + y0 .

(c) V ar[yt ] E[(yt E[yt ])2 ] = E[( tj=1 j + t )2 ] = tj=1 E[2j ] + E[t2 ] = 2 t + 2 .

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

t
(d) Cov[yt , yth ] E[(yt E[yt ])(yth E[yth ])] = E[( j=1 j + t )( th
j=1 j + th )] =
th
j=1 E[2j ] = 2 (t h).
(e) {yt } is not covariance stationary since E[yt ] = ct + y0 depends on time t.

Problem-4: Suppose that {xt } follows random walk with drift:

xt = d + xt1 + xt , (13)

where {xt } is white noise with E[2xt ] = x2 , and x0 is a non-stochastic initial value. Also

suppose that
yt = a + bxt + yt , (14)

where {yt } is white noise with E[2yt ] = y2 , y0 = 0 is a non-stochastic initial value, and

E[xt ys ] = 0 for any t and s.

t
(a) Show that yt = bdt + a + bx0 + b j=1 xj + yt .

(b) Show that {yt } follows random walk with drift and noise. (Hint: Use part (a) of

Problem-3.)

(c) Compute E[yt ]. (Hint: Use part (b) of Problem-3.)

(d) Compute V ar[yt ] E[(yt E[yt ])2 ]. (Hint: Use part (c) of Problem-3.)

(e) Compute Cov[yt , yth ] E[(yt E[yt ])(yth E[yth ])]. (Hint: Use part (d) of Problem-
3.)

(f) Assume that x0 = 0, a = b = 0.5, d = 0.3, = 1, and

xt i.i.d. 0 1 0
N , .
yt 0 0 1.5

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

Under these assumptions, we simulate {xt }100

t=1 from (13) and {yt }t=1 from (14). We
100

then run a linear regression model

yt = + xt + ut , t = 1, 2, . . . , 100, (15)

and get ordinary least squares estiamtors and . Residual is ut = yt xt . See

Panels 1-3 of Figure 1. Each panel plots {xt }, {yt }, or {ut }. Answer which panel plots
which series, and write a brief reason for your answer using a keyword cointegration.

t
Solution-4: (a) Eq. (13) can be rewritten as xt = dt + x0 + j=1 xj . Hence

yt = a + bxt + yt
( )

t
= a + b dt + x0 + xj + yt
(16)
j=1

t
= bdt + a + bx0 + b xj + yt .
j=1

(b) Eq. (16) is a special case of Eq. (12) with c = bd, y0 = a + bx0 , t = bxt , t = yt ,

2 = b2 x2 , and 2 = y2 . Hence {yt } in Eq. (16) follows random walk with drift and noise.

(c) We have from part (b) of Problem-3 and part (b) of Problem-4 that E[yt ] = bdt +
a + bx0 .

(d) We have from part (c) of Problem-3 and part (b) of Problem-4 that V ar[yt ] =
b2 x2 t + y2 .
(e) We have from part (d) of Problem-3 and part (b) of Problem-4 that Cov[yt , yth ] =
b2 x2 (t h).
(f) The series in Panel 1 seems covariance stationary. The series in Panels 2 and 3 seem
nonstationary due to an upward trend, and there is more noise in Panel 3 than in Panel 2.
Recall that {xt } follows random walk with drift and {yt } follows random walk with drift and

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

noise. Hence it must be the case that Panel 2 plots {xt } and Panel 3 plots {yt }.
Eq. (14) indicates that there is cointegration between {yt } and {xt } both {yt } and
{xt } are nonstationary but there exists a linear combination yt = yt a bxt that is
covariance stationary (in fact white noise). Since model (15) is correctly specified relative
to Eq. (14), the residual {ut } must be covariance stationary. Hence it must be the case that
Panel 1 plots {ut }.

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Time Series Analysis Final Exam Kaiji Motegi
Fall 2016 Solutions Kobe University

-5
0 50 100
1. {xt }, {yt }, or {ut }?

30

20

10

0
0 50 100
2. {xt }, {yt }, or {ut }?

15

10

-5
0 50 100
3. {xt }, {yt }, or {ut }?

Figure 1: Cointegration