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Tutorial 9 Solutions

The document discusses time series analysis, specifically focusing on covariance-stationary series and mean-reverting levels, with calculations for predicting changes in the unemployment rate. It highlights the limitations of long-term forecasts using AR(1) models and the importance of data selection for ensuring stationarity. Additionally, it outlines a method for estimating regression and analyzing residuals to assess model validity.

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51 views2 pages

Tutorial 9 Solutions

The document discusses time series analysis, specifically focusing on covariance-stationary series and mean-reverting levels, with calculations for predicting changes in the unemployment rate. It highlights the limitations of long-term forecasts using AR(1) models and the importance of data selection for ensuring stationarity. Additionally, it outlines a method for estimating regression and analyzing residuals to assess model validity.

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4035889
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FIN/MAN305 Financial & Analytical Techniques

Tutorial 9 • Time Series Analysis


Solutions

1. When a covariance-stationary series is at its mean-reverting level, the


series will tend not to change until it receives a shock (c.). So, if the
series ∆UERr is at the mean-reverting level, ∆UERr = ∆UERr-l· This
implies that ∆UERr = -0.0668 - 0.2320∆UERr, so that (1 +
0.2320)∆UERr = -0.0668 and ∆UERr = -0.0668/(1 +
0.2320) =
-0.0542. The mean-reverting level is -0.0542. In an AR(l) model, the
general expression for the mean-reverting level is b0/(1 - b1).
2. A. The predicted change in the unemployment rate for next period is -
7.38 percent,
found by substituting 0.0300 into the forecasting model: -0.0668 -
0.2320(0.03) =
-0.0738.
B. If we substitute our one-period-ahead forecast of -0.0738 into the
model (using the chain rule of forecasting), we get a two-period-
ahead forecast of -0.0497, or
-4.97 percent.
C. The answer to Part B is quite dose to the mean-reverting level of -
0.0542. A stationary time series may need many periods to return to
its equilibrium, mean reverting level.
3. A. Predictions too far ahead can be nonsensical. For example, the AR(l)
model we have been examining, ∆UERr = -0.0405 - 0.4674∆UER t-
l> taken at face value, predicts declining civilian unemployment into
the indefinite future. Because the civilian unemployment rate will
probably not go below 3% frictional unemploy ment and cannot go
below 0 percent unemployment, this model's long-range forecasts
are implausible. The model is designed for short-term forecasting, as
are many time-series models.
B. Using more years of data for estimation may lead to nonstationarity
even in the series of first differences in the civilian unemployment rate.
As we go further back in time, we increase the risk that the
underlying civilian unemployment rate series has more than one
regime (or true model). If the series has more than one regime,
fitting one model to the entire period would not be correct. Note
that when we have good reason to believe that a time series is
stationary, a longer series of data is generally desirable.
4. We should estimate the regression ∆UERr = b0 + b1∆UERt-l + er and
save residuals from the regression. Then we should create a new variable,
2 2 2
ε^ t by squaring the residuals. Finally, we should estimate ε^ t =a 0 +a1 ε^ t −1 and
test to see whether a 1 is statistically different from 0.

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