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# Business and Economic Forecasting EMET3007/EMET8012 Problem Set 1

Assignment 1 consists of 4 + 1 problems, and is due by 5 pm on Wednesday 14 August. The question marked with a hash (#) is for postgraduate students only. 1. (7 points) Let X1 , . . . , Xm and Y1 , . . . , Yn be independent and identically distributed (iid) observations with common mean and variance and 2 , respectively. Let X and Y denote the sample means, i.e., = 1 X m
m

Xi ,
i=1

= 1 Y n

Yi .
i=1

Consider the following two estimators of : 1 = (a) Find E(1 ) and E(2 ). (b) Find Var(1 ) and Var(2 ). (c) Which estimator is better? Explain your answer. (d) Now suppose X1 , . . . , Xm and Y1 , . . . , Yn are iid N(, 2 ) random variables. Find the distributions of 1 and 2 . 2. (5 points) Suppose y N(X , ), where X, and are known matrices. Furthermore, is symmetric, i.e., = . Let = (X 1 X)1 X 1 y. (a) Find the expected value E( ). (b) Find the covariance matrix of . (c) What is the distribution of ? 3. (6 points) Write a MATLAB script to generate data from the following AR(2) process with a drift: yt = + 1 yt1 + 2 yt2 + t , t N(0, 2 ), for t = 1, 2, . . . , T , where the process is initialized with y1 = y0 = . Set T = 50, = 5, 1 = 0.5, 2 = 0.1 and 2 = 2. (a) Plot one realization of the AR(2) process. (b) Generate 1000 realizations of the AR(2) process. For each series, compute the sample mean and sample variance. Plot histograms of the sample means and sample variances. +Y X , 2 2 = + nY mX . m+n

4. (7 points) Suppose we wish to make an iterated two-step-ahead forecast using the AR(2) model in Exercise 3. (a) Compute the conditional expectation E(yT +2 | IT , ), where IT is the information set at time t = T and = (, ) . (b) Is this point forecast optimal in any well-dened sense? Explain. (c) Derive also the conditional density f (yT +2 | IT , ). (d) Using the values yT = 15, yT 1 = 18, yT 2 = 12, = 5, 1 = 0.5, 2 = 0.1 and 2 = 2, compute the probability that yT +2 > 16. 5. (7 points) Suppose we wish to compare the forecast accuracy of two simple methods for forecasting Australian unemployment rate: (1) the random-walk method that uses only the most recent observation and (2) a simple weighted average using the past three observations: yt+1 = 0.5yt + 0.25yt1 + 0.25yt2 .
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Table 1: Australian unemployment rate Quarter ination 2011-01 5.4 5.6 2011-02 2011-03 5.3 2011-04 5.0 2011-05 5.0 2011-06 4.8 2011-07 4.8 2011-08 5.1 2011-09 5.2 2011-10 5.0 2011-11 4.9 2011-12 5.0

from January 2011 to December 2012. Quarter ination 2012-01 5.5 2012-02 5.9 2012-03 5.5 2012-04 5.0 2012-05 5.2 2012-06 5.0 2012-07 4.9 2012-08 5.0 2012-09 5.5 2012-10 5.2 2012-11 4.9 2012-12 5.2

The evaluation period is from May 2011 to December 2012. As for measures of accuracy, we consider MAPE, sMAPE, MdRAE and MASE (for details see Hyndman and Koehler, 2006). (a) Use the two methods to produce 1-step-ahead forecasts from May 2011 to December 2012. (b) Compute the four measures of forecast accuracy for the two methods. For this problem you may use any of your favorite software (MATLAB, Excel, hand-held calculator, etc.). 2