WORKSHOP

on

Advanced Time Series

Econometrics with EViews
Asst. Prof. Dr. Kemal Bagzibagli
Department of Economic

Res. Asst. Pejman Bahramian

PhD Candidate, Department of Economic

Res. Asst. Gizem Uzuner

MSc Student, Department of Economic
EViews Workshop Series Agenda
1.  Introductory Econometrics with Eviews

2.  Advanced Time Series Econometrics with Eviews

3.  Forecasting, and Volatility Models with EViews

a.  Forecasting
b.  Volatility models
c.  Regime Switching Models

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Part 2 - Outline
1.  Unit root test and cointegration
2.  Vector Autoregressive (VAR) models
3.  Structural Vector Autoregressive (SVAR) models
4.  Vector Error Correction Models (VECM)
5.  Autoregressive Distributed Lag processes

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1.1 Unit Root
Why do We Need the Unit Root Tests?
All assumptions are made on stationary series,
but time series are generally nonstationary.
In order to examine this issue, we can apply the
following tests:
●  DICKEY-FULLER TEST
●  AUGMENTED DICKEY-FULLER
●  PHILIPS-PERRON
●  KPSS TEST
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Dickey-Fuller Test
●  The simplest approach to test for the unit root
●  Begins with AR(1) model.

●  Hypothesis testing:
H0: δ = 0 (no unit root)
H1: δ = 1 (unit root)
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Augmented Dickey-Fuller Test
Let Yt be a time series. Deriving from AR(p)
representation, the ADF test involves the
following regressions:

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Comparing DF and ADF Tests
●  True model structure: AR(2) or AR(3)
●  We model it as AR(1)
  Autocorrelation problem will occur
●  In order to avoid the autocorrelation
problem: ADF test is suggested
●  The tests have the same hypothesis
structure 8
Applications with EViews

1.0000

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Applications with EViews (cont.)

0.2867

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Applications with EViews (cont.)

0.8476

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Applications with EViews (cont.)
Remedy: First difference of the series

0.0000

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Applications with EViews (cont.)

0.0000

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Phillips Perron Test
●  A more comprehensive theory of unit root
nonstationarity.
●  Similar to ADF tests,
○  but incorporates an automatic correction to the DF
procedure to allow for autocorrelated residuals.

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Applications with EViews

1.0000

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Applications with EViews (cont.)

0.1861

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Applications with EViews (cont.)

0.8459

17
Applications with EViews (cont.)

0.0000

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Applications with EViews (cont.)

0.0000

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Critics to the Dickey Fuller and Phillips
Perron Tests
●  Power of the tests is low if
o  the process is stationary
o  but with a root close to the non-stationary
boundary (1):

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Critics to the Dickey Fuller and Phillips
Perron Tests (cont.)
Hypotheses of the ADF/PP tests:
H0 : Yt〜～ I (1)
H1: Yt〜～ I (0)
●  According to the null hypothesis, a unit root should
be a rejected.
●  The tests are poor at deciding, for example,
whether φ = 1 or φ = 0.95, especially with small
sample sizes.
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KPSS Test
●  The aim of this test is to remove
deterministic trend of the series in order to
make it stationary.
●  The hypotheses differ from that of the ADF
test:
H0 : Yt〜～ I (0)
H1: Yt〜～ I (1)
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Applications with EViews

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Applications with EViews (cont.)

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Applications with EViews (cont.)

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Summary

DICKEY AUGMENTED PHILLIPS

KPSS TEST
FULLER DICKEY FULLER PERRON

Developed
Modelling with Modelling with Modelling with
nonparametric
AR(1) process AR(p) process MA process
test

H0: Yt〜 I (1) H0 : Yt〜 I (1) H0 : Yt〜 I (1) H0 : Yt〜 I (0)

H1: Yt〜 I (0) H1 : Yt〜 I (0) H1 : Yt〜 I (0) H1 : Yt〜 I (1)

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1.2 Cointegration
What is Cointegration?
●  Two nonstationary series may have the property that a
particular linear combination of them, e.g. Xt - aYt , is
stationary
●  If such a property holds
Xt and Yt are cointegrated
●  Two cointegrated series will not drift too far apart over
the long run.
●  e.g. consumption-income, prices of two close
substitutes, prices and wages in two related markets 28
What is Cointegration? (cont.)
●  The analysis of short run dynamics is often
done by first eliminating trends in variables,
usually by differencing.
●  This procedure, however, throws away
potential valuable information
o  e.g. long run relationships about which economic
theories have a lot to say.

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What is Cointegration? (cont.)
Lemma 1: Series Xt and Yt are I(1) if these
series are cointegrated, then Xt and Yt+φ are
also cointegrated.
Lemma 2: If two series are cointegrated, they
also have a Granger causality
●  However, we cannot know the direction of
the causality.
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Detection of Cointegration
●  Engle-Granger Approach (1987)
●  Johansen Approach (1990)
●  Autoregressive Distributed Lag (ARDL)
Approach (2001)

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Granger Causality
●  Granger (1969): first attempt at testing for
the direction of causality
●  Suppose X Granger-causes Y
o  but Y does not Granger-cause X
●  Then past values of X should be able to help
predict future values of Y
o  but past values of Y should not be helpful in
forecasting X 32
Engle-Granger (1987) Test for
Causality
STEP 1:
●  Test the variables for stationarity.
●  If they are stationary, the conventional LS
estimation is appropriate.
●  If they are not stationary in the SAME
DEGREE, go to Step 2

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Engle-Granger Test for Causality (cont.)
STEP2:
●  Estimate the equation like,

(Command: ls y c x )

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Engle-Granger Test ( cont.)
STEP 3:
●  If ut is stationary, i.e. I(0)
●  THEN the variables are cointegrated.

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STEP 1

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STEP 1 (cont.)
For LNINF

0.2229

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STEP 1 (cont.)

0.0592

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STEP 1 (cont.)

0.4493

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STEP 1 (cont.)

0.0000

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STEP 1 (cont.)
For LNUNEMP

0.7374

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STEP 1 (cont.)

0.1509

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STEP 1 (cont.)

0.2266

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STEP 1 (cont.)

0.0010

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STEP 1 (cont.)
Conclusion
★ Both lninflation and lnunemployment
series are stationary in the same degree,
I(1)
★ THEN we can go to Step 2.

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STEP 2
lninflation = β0+ β1lnunemployment + u
(Command: ls lninf c lnu)

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STEP 2

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STEP 3

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STEP 3
❖  So, ut is stationary.
❖  According to the Engle-Granger test,
lnunemployment and lninflation series are
cointegrated.

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The Johansen Approach
●  If the model has more than two variables, then there
can be more than one cointegration relation.
●  Generally, for m number of observations, we could have
m-1 number of cointegration vectors.
●  Assume that all variables are endogenous in the model
and no need to choose any variables for normalization.

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The Johansen Approach (cont.)
STEP 1: Determine the cointegration
integrated degree for the number of m variables
by the unit root test.
●  Most of the economic indicators are
nonstationary
o  using the unit root test also prevents the spurious
regression problem.

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The Johansen Approach (cont.)
STEP 2: Find the appropriate lag order via lag-
length criteria using a vector autoregressive
(VAR) model.
●  This step is important to ensure that the
error term comes from a white noise
process.

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The Johansen Approach (cont.)
STEP 3 : Model selection according to
deterministic component.

•  In general it is better to select number 6

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Applications with EViews

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Applications with EViews (cont.)

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Applications with EViews (cont.)

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Applications with EViews (cont.)

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Applications with EViews (cont.)

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Applications with EViews (cont.)

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Enger-Granger vs. Johansen Approaches
●  Engle-Granger is manual method for the
cointegration test.
○  Disadvantage:
■  It gives maximum one cointegration relation (even if
there are more than one cointegration relations).
●  Johansen approach is very superior than the
Engle-Granger
o  Restriction:
§  variables have to be in the same integrated order.
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2. Vector Autoregression
(VAR) Models
Vector Autoregression (VAR) Models
●  The VAR is commonly used for forecasting systems of
interrelated time series and for analyzing the dynamic
impact of random disturbances on the system of
variables

●  The mathematical representation of a VAR is

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Vector Autoregression (VAR) Models (cont.)
●  As an example, suppose that industrial production (IP)
and money supply (M1) are jointly determined by a VAR
and let a constant be the only exogenous variable.

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 Estimating a VAR in Eviews
•  Create a VAR Object. Select Quick/
Estimate VAR
•  Select the VAR type: Unrestricted
VAR.
•  Set the estimation sample
•  Enter the lag specification
•  Enter the names of endogenous and
exogenous series

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VAR Estimation Output

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Views and Procs of a VAR
Once you have estimated a VAR,
EViews provides various view to work
with the estimated VAR.

On the estimation output window select

view

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Lag Structure

AR Roots Table

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AR Roots Graph
Reports the inverse roots of the Inverse Roots of AR Characteristic Polynomial
characteristic AR polynomial
 
The estimated
  VAR is stable
 
(stationary) if all roots have
modulus less than one and lie
inside the unit circle.

If the VAR is not stable, certain

results (such as impulse response
standard errors) are not valid.

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Lag Length Criteria

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Residual Tests

Correlograms:

Displays the pairwise crosscorrelograms

(sample autocorrelations) for the estimated
Residuals In the VAR for the specified
number of lags.
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Portmanteau Autocorrelation Test
Computes the multivariate Box-Pierce/Ljung-Box Q-statistics
for residual serial correlation up to the specified order

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Impulse Responses
A shock to the i-th variable not only directly affects the i-th variable but
is also transmitted to all of the other endogenous variables through the
dynamic (lag) structure of the VAR.

An impulse response function traces the effect of a one-time shock to

one of the innovations on current and future values of the endogenous
variables.

Application:
First estimate a VAR. Then select View/Impulse Response
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Impulse Responses (cont.)
Display Format: displays
results as a table or graph.

Display Information: you

should enter the variables
for which you wish to
generate
innovations (Impulses) and
the variables for which you
wish to observe the
responses (Responses)
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Impulse Responses (cont.)
Response Standard Errors: provides options for computing the response
standard errors. Note that analytic and/or Monte Carlo standard errors are
currently not available for certain Impulse options and for vector error correction
(VEC) models

Impulse Definition Residual—One Unit sets

the impulses to one unit
of the residuals.

Residual—One Std. Dev.

sets the impulses to one
standard deviation of the
residuals
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Impulse Responses (cont.)
Cholesky uses the inverse of the Cholesky factor of the residual
covariance matrix to orthogonalize the impulses

Generalized Impulses constructs an orthogonal set of

innovations that does not depend on the VAR ordering

Structural Decomposition uses the orthogonal transformation

estimated from the structural factorization matrices.

User Specified allows you to specify your own impulses

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Impulse Responses (cont.)

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Variance Decomposition
Separates the variation in an endogenous variable into the
component shocks to the VAR.

Provides information
about the relative
importance of each
random innovation in
affect

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Variance Decomposition (cont.)

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 3. Structural Vector
Autoregression (SVAR)
Models
Structural (Identified) VARs
The main purpose of SVAR estimation is to obtain non-recursive
orthogonalization of the error terms for impulse response
analysis

In order to estimate the orthogonal factorization matrices you

need to provide additional identifying restrictions.

Two types of identifying restrictions: short-run and long-run. For

either type, the identifying restrictions can be specified either in
text form or by pattern matrices.
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Short-run Restrictions by Pattern Matrices
you can specify the restrictions by creating a named “pattern” matrix.
Any elements of the matrix that you want to be estimated should be
assigned a missing value “NA”.

For example, suppose you want to restrict to be a lower triangular

matrix with ones on the main diagonal and to be a diagonal matrix.
Then the pattern matrices (for a variable VAR) would be:

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Applications with EViews
To Create Two New Matrices, A and B (3*3), Use Object/New
Object and Then Use The Spreadsheet View To Edit The Values. Or
You can write the following on command window
matrix(3,3) pata
’ fill matrix in row major order
pata.fill(by=r) 1,0,0, na,1,0,
na,na,1
matrix(3,3) patb = 0
patb(1,1) = na
patb(2,2) = na
patb(3,3) = na

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Applications with EViews
matrix(3,3) patb = 0
matrix(3,3) pata patb(1,1) = na
pata.fill(by=r) 1,0,0, na,1,0, na,na,1 patb(2,2) = na
patb(3,3) = na

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 Applications with EViews (cont.)
Select Proc/Estimate
Structural Factorization
from the VAR window
menu. In the SVAR
Options dialog, click the
Matrix button and the
Short-Run Pattern
button and type in the
name of the pattern
matrices in the relevant
edit boxes.
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 Applications with EViews (cont.)
Short-run Restrictions in Text Form

In text form, write out the relation

as a set of equations

K=3, variable VAR you have where you want to restrict A to be a lower
triangular matrix with ones on the main diagonal and to be a diagonal matrix.

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Applications with EViews (cont.)
To specify these restrictions in text form, select Proc/
Estimate Structural Factorization from the VAR window
and click the Text button. In the edit window, you should
type the Following:

@e1= c1*@u1
@e2= -c2@*e1 +c3*@u2
@e3= -c4@*e1 –c5*@e2 + c6*@ u3

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Long-run Restrictions
The long run response C to structural innovations take the form:

𝑪=  ​𝜳↓∞    ​𝑨↑−𝟏   𝑩

Suppose you have a variable VAR where you want to restrict the long-run
response of the second endogenous variable to the first structural shock to
be zero . Then the long-run response matrix will have the following
pattern:

Matrix (2,2) patc= na

Patc(2,1) = 0

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Long-run Restrictions (cont.)
Once you have created the pattern matrix, select Proc/Estimate
Structural Factorization from the VAR window menu. In the SVAR
Options dialog, click the Matrix button and the Long-Run Pattern button
and type in the name of the pattern matrix in the relevant edit box.

To specify the same long-run restriction in text form, select Proc/

Estimate Structural Factorization from the VAR window and click the
Text button. In the edit window, you would type the following:

@lr2(@u1)=0 ‘ zero LR response of 2nd variable to 1st shock

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4. Vector Error Correction
Models (VECMs)
Vector Error Correction (VEC) Models
VEC model (VECM) is a restricted VAR designed for use with
nonstationary series that are known to be cointegrated

Consider a two variable system with one cointegrating equation and no

lagged Difference terms. The cointegrating equation is

The corresponding VECM is:

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Estimate VECM
To set up a VEC, click the Estimate button in the VAR
toolbar and choose the Vector Error Correction
specification from the VAR/VEC Specification tab.

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VECM Estimation Output
The VEC estimation output consists of two parts. The first part reports the
results from the first step Johansen procedure default

The second part of the output reports results from the second step VAR in
first differences, including the error correction terms estimated from the first
step

The error correction terms are denoted CointEq1 in the output.

At the bottom of the VEC output table, you will see two log likelihood values
reported for the system. The first value, labeled Log Likelihood (d.f.
adjusted), is computed using the determinant of the residual covariance
matrix.
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VECM Estimation Output (cont.)

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 VECM Estimation Output (cont.)

The Log Likelihood

value is computed using
the residual covariance
matrix without correcting
for degrees of freedom

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VECM Estimation Output (cont.)
Cointegrating Relations

To store these estimated

cointegrating relations as
named series in the
workfile, use Proc/Make
Cointegration Group

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5. Autoregressive
Distributed Lag
processes
Autoregressive Distributed Lag (ARDL)

●  An ARDL process refers to a model with lags of

both the dependent and explanatory variables.
●  An ARDL(1,1) model would have 1 lag on both
variables:

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Autoregressive Distributed Lag (cont.)

Generalized ARDL(p, q);

❖  One condition:
➢  dependent variable is integrated 1, I(1),
➢  but independent variables can have different
integrated order except I(2).
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Bibliography
●  Brooks, C. (2008) Introductory Econometrics for Finance,
●  Gujarati D.N., Porter D.C. (2004), Basic Econometrics,The McGraw−Hill
Companies
●  Maddala, G.S. (2002). Introduction to Econometrics.
●  Ramanathan, R. (2002). Introductory econometrics with applications,
Thompson Learning. Mason, Ohio, USA.
●  Wooldridge,J. (2000) Introductory Econometrics: A modern Approach.
South-Western College Publishing

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