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Time Series for Macroeconomics and Finance
John H. Cochrane
1
Graduate School of BusinessUniversity of Chicago5807 S. Woodlawn.Chicago IL 60637(773) 702-3059 john.cochrane@gsb.uchicago.eduSpring 1997; Pictures added Jan 2005
1
I thank Giorgio DeSantis for many useful comments on this manuscript. Copy-rightc
°
John H. Cochrane 1997, 2005
 
Contents
1 Preface 72 What is a time series? 83 ARMA models 10
3.1 White noise . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103.2 Basic ARMA models . . . . . . . . . . . . . . . . . . . . . . . 113.3 Lag operators and polynomials . . . . . . . . . . . . . . . . . 113.3.1 Manipulating ARMAs with lag operators. . . . . . . . 123.3.2 AR(1) to MA(
∞
) by recursive substitution . . . . . . . 133.3.3 AR(1) to MA(
∞
) with lag operators. . . . . . . . . . . 133.3.4 AR(p) to MA(
∞
), MA(q) to AR(
∞
), factoring lagpolynomials, and partial fractions . . . . . . . . . . . . 143.3.5 Summary of allowed lag polynomial manipulations . . 163.4 Multivariate ARMA models. . . . . . . . . . . . . . . . . . . . 173.5 Problems and Tricks . . . . . . . . . . . . . . . . . . . . . . . 19
4 The autocorrelation and autocovariance functions. 21
4.1 De
fi
nitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214.2 Autocovariance and autocorrelation of ARMA processes. . . . 224.2.1 Summary . . . . . . . . . . . . . . . . . . . . . . . . . 251
 
4.3 A fundamental representation . . . . . . . . . . . . . . . . . . 264.4 Admissible autocorrelation functions . . . . . . . . . . . . . . 274.5 Multivariate auto- and cross correlations. . . . . . . . . . . . . 30
5 Prediction and Impulse-Response Functions 31
5.1 Predicting ARMA models . . . . . . . . . . . . . . . . . . . . 325.2 State space representation . . . . . . . . . . . . . . . . . . . . 345.2.1 ARMAs in vector AR(1) representation . . . . . . . . 355.2.2 Forecasts from vector AR(1) representation . . . . . . . 355.2.3 VARs in vector AR(1) representation. . . . . . . . . . . 365.3 Impulse-response function . . . . . . . . . . . . . . . . . . . . 375.3.1 Facts about impulse-responses . . . . . . . . . . . . . . 38
6 Stationarity and Wold representation 40
6.1 De
fi
nitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 406.2 Conditions for stationary ARMA’s . . . . . . . . . . . . . . . 416.3 Wold Decomposition theorem . . . . . . . . . . . . . . . . . . 436.3.1 What the Wold theorem does not say . . . . . . . . . . 456.4 The Wold MA(
∞
) as another fundamental representation . . . 46
7 VARs: orthogonalization, variance decomposition, Grangercausality 48
7.1 Orthogonalizing VARs . . . . . . . . . . . . . . . . . . . . . . 487.1.1 Ambiguity of impulse-response functions . . . . . . . . 487.1.2 Orthogonal shocks . . . . . . . . . . . . . . . . . . . . 497.1.3 Sims orthogonalization–Specifying
C 
(0) . . . . . . . . 507.1.4 Blanchard-Quah orthogonalization—restrictions on
C 
(1). 527.2 Variance decompositions . . . . . . . . . . . . . . . . . . . . . 537.3 VAR’s in state space notation . . . . . . . . . . . . . . . . . . 542
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