Rossi VAR PHD PDF

Universit`a di Pavia
Vector AutoRegression Model

Eduardo Rossi
VAR
Vector autoregressions (VARs) were introduced into empirical
economics by C.Sims (1980), who demonstrated that VARs provide a
exible and tractable framework for analyzing economic time series.
Identication issue: since these models dont dichotomize variables
into endogenous and exogenous, the exclusion restrictions used to
identify traditional simultaneous equations models make little sense.
A Vector Autoregression model (VAR) of order p is written as:
y
t
= c +
1
y
t1
+ . . . +
p
y
tp
+
t
y
t
: (N 1)
i
: (N N) i,
t
: (N 1)
E(
t
) = 0 E(
t
) =
_
_
_
t =
0 t =
positive denite matrix.
Eduardo Rossi c - Time Series Econometrics 11 2
VAR(p)
A VAR is a vector generalization of a scalar autoregression.
The VAR is a system in which each variable is regressed on a
constant and p of its own lags as well as on p lags of each of the other
variables in the VAR.
[I
N

1
L
p
L
p
] y
t
= c +
t
(L)y
t
= c +
t
with
(L) = [I
N

1
L
p
L
p
]
(L) (N N) matrix polynomial in L.
VAR(p) - Stationarity
The element (i, j) in (L) is a scalar polynomial in L
ij
(1)
ij
L
(2)
ij
L
2
. . .
(p)
ij
L
p
ij
=
_
_
_
1 i = j
0 i = j
Stationarity: A vector process is said covariance stationary if its
rst and second moments, E[y
t
] and E[y
t
y
tj
] respectively, are
independent of the date t.
VAR(1)
y
t
= c +
1
y
t1
+
t
First equation:
y
1t
= c
1
+
(1)
11
y
1t1
+
(1)
12
y
2t1
+ . . . +
(1)
1N
y
Nt1
+
1t
y
t
= c +
1
[c +
1
y
t2
+
t1
] +
t
= c +
1
c +
2
1
y
t2
+
t
+
1
t1
y
t
= . . .
y
t
= c +
1
c + . . . +
k1
1
c +
k
1
y
tk
+
t
+
1
t1
+ . . . +
k1
1

tk+1
E[y
t
] =
k1
j=0
j
1
c +
k
1
E[y
tk
]
The value of this sum depends on the behavior of
j
1
as j increases.
Stability of VAR(1)
Let
1
,
2
, . . . ,
N
be the eigenvalues of
1
, the solutions to the
characteristic equation
|
1
I
N
| = 0
then, if the eigenvalues are all distinct
1
= QMQ
1
k
1
= QM
k
Q
1
M
k
= diag(
k
1
,
k
2
, . . . ,
k
N
)
If |
i
| < 1, i = 1, . . . , N
k
0, k
If |
i
| 1, i then one or more elements of M
k
are not vanishing,
and may be tending to .
VAR(P) Companion form
VAR(p):
y
t
=
1
y
t1
+ . . . +
p
y
tp
+
t
as a VAR(1) (Companion Form):
t
= F
t1
+v
t
t
=
_
_
y
t
.
.
.
y
tp+1
_
_
(Np 1)
t1
=
_
_
y
t1
.
.
.
y
tp
_
_
(Np 1)
VAR(P) Companion form
F =
_
1

2
. . .
p1

p
I
N
0 . . . 0 0
0 I
N
. . . 0 0
.
.
.
.
.
.
.
.
.
.
.
.
0 0 . . . I
N
0
_
_
(NpNp) v
t
=
_
t
0
.
.
.
0
_
_
(Np1)
E[v
t
v
] =
_
_
_
Q t =
0 t =
Q =
_
_
0 . . . 0
0 0 . . . 0
.
.
.
.
.
.
.
.
.
0 0 . . . 0
_
_
(Np Np)
Stability of VAR(p)
y
t
=
1
y
t1
+ . . . +
p
y
tp
+
t
t = 1, . . . , T
If the process y
t
has nite variance and an autocovariance sequence
that converges to zero at an exponential rate, then
t
must share
these properties. This is ensured by having the Np eigenvalues of F
lie inside the unit circle.
The determinant dening the characteristic equation is
|F I
Np
| = (1)
Np
|
p
I
N

p1
1
. . .
p
| = 0
Stability of VAR(p)
The required condition is that the roots of the equation
|
p
I
N

p1
1
. . .
p
| = 0
a polynomial of order Np must lie inside the unit circle.
Stability condition can also be expressed as the roots of
|(z)| = 0
lie outside the unit circle, where (z) is a (N N) matrix
polynomial in the lag operator of order p.
Stability of VAR(p)
When p = 1, the roots of
|I
N

1
z| = 0
outside the unit circle, i.e. |z| > 1, implies that the eigenvalues of
1
be inside the unit circle. Note that the eigenvalues, roots of
|
1
I
N
| = 0, are the reciprocal of the roots of |I
N

1
z| = 0.
Stability of VAR(p)
Three conditions are necessary for stationarity of the VAR(p) model:
Absence of mean shifts;
The vectors {
t
} are identically distributed, t;
Stability condition on F.
If the process is covariance stationary we can take the expectations of
both sides of
y
t
= c +
1
y
t1
+ . . . +
p
y
tp
+
t
= c +
1
+ . . . +
p
= [I
N

1
. . .
p
]
1
c
= (1)
1
c
Vector MA()
If the VAR(p) is stationary then it has a VMA() representation:
y
t
= +
t
+
1
t1
+
2
t2
+ . . . +(L)
t
y
tj
is a linear function of
tj
,
tj1
, . . . each of which is
uncorrelated with
t+1
for j = 0, 1, . . ..
It follows that

t+1
is uncorrelated with y
tj
for any j 0.
Linear forecast of y
t+1
based on y
t
, y
t1
, . . . is given by
y
t+1|t
= +
1
(y
t
) +
2
(y
t1
) +. . . +(y
tp+1
)
Forecasting with VAR
t+1
can be interpreted as the fundamental innovation in y
t+1
, that
is the error in forecasting y
t+1
on the basis of a linear function of a
constant and y
t
, y
t1
, . . ..
A forecast of y
t+s
on the basis of y
t
, y
t1
, . . . will take the form
y
t+s|t
= +F
(s)
11
(y
t
) +F
(s)
12
(y
t1
) +. . . +F
(s)
1p
(y
tp+1
)
The moving average matrices
j
can be calculated as:
(L) = [(L)]
1
(L)(L) = I
N
VMA coefficient matrices
[I
N
+
1
L +
2
L
2
+ . . .][I
N

1
L
2
L
2
+ . . .
p
L
p
] = I
N
Setting the coecient on L
1
equal to the zero matrix,
1
= 0
on L
2
2
=
1
1
+
2
In general for L
s
s
=
1
s1
+ . . . +
p
sp
s = 1, 2, . . .
0
= I
N
,
s
= 0 s < 0
The innovation in the MA() representation is
t
, the fundamental
innovation for y.
There are alternative MA representation based on VWN processes
other than
t
.
Let H be a nonsingular (N N) matrix
u
t
H
t
u
t
V WN.
y
t
= +H
1
H
t
+
1
H
1
H
t1
+ . . .
= +J
0
u
t
+J
1
u
t1
+J
2
u
t2
+ . . .
J
s

s
H
1
For example H can be any matrix that diagonalizes , the var-cov of
t
,
HH
= D
the elements of u
t
are uncorrelated with one another.
It is always possible to write a stationary VAR(p) process as a
convergent innite MA of a VWN whose elements are mutually
uncorrelated.
To obtain the MA representation for the fundamental innovations, we
must impose
0
= I
N
(while J
0
is not the identity matrix).
Assumptions implicit in a VAR
For a covariance stationary process, the parameters c,
1
, . . . ,
p
could be dened as the coecients of the projections of y
t
on
1, y
t1
, y
t2
, . . . , y
tp
.

t
is uncorrelated with y
t1
, . . . , y
tp
by the denition of
1
, . . . ,
p
.
The parameters of a VAR can be estimated consistently with n
OLS regressions.

t
dened by this projection is uncorrelated with
y
tp1
, y
tp2
, . . .
The assumption of y
t
V AR(p) is basically the assumption that
p lags are sucient to summarize the dynamic correlations
between elements of y.
Vector MA(q) Process
y
t
= +
t
+
1
t1
+ . . . +
q
tq
t
V WN,
j
(N N) matrix of MA coecients j = 1, 2, . . . , q.
E(y
t
) =
0
= E[(y
t
)(y
t
)
]
= E[
t
t
] +
1
E[
t1
t1
]
1
+ . . . +
q
E[
tq
tq
]
q
= +
1
1
+ . . . +
q
q
Vector MA(q) Process
j
= E[(
t
+
1
t1
+ . . . +
q
tq
)(
tj
+
1
tj1
+ . . . +
q
tjq
)
j
=
_
j
+
j+1
1
+
j+2
2
+ . . . +
q
q1
j = 1, . . . , q
j
+
1
j+1
+ . . . +
q+j
q
j = 1, . . . , q
0 |j| > q
0
= I
N
. Any VMA() is covariance stationary.
VAR(p) Autocovariances
Given:
j
= E[(y
t
)(y
tj
)
j
= E[(y
t
)(y
t+j
)
]
then
j
=
j
j
=
j
{
j
}
1,2
= cov(y
1t
, y
2tj
)
{
j
}
2,1
= cov(y
2t
, y
1tj
)
{
j
}
1,2
= cov(y
1t
, y
2t+j
)
j
= E[(y
t+j
)(y
(t+j)j
)
]
= E[(y
t+j
)(y
t
)
j
= E[(y
t
)(y
t+j
)
] =
j
Companion form:
t
= F
t1
+v
t
= E[
t
t
]
= E
_
_
_
_
y
t
y
t1
.
.
.
y
tp+1
_
[(y
t
)
. . . (y
tp+1
)
]
_
_
=
_
0

1
. . .
p1
1

0
. . .
p2
.
.
.
.
.
.
p1

p2
. . .
0
_
_
(Np Np)
E[
t
t
] = E[(F
t1
+v
t
)(F
t1
+v
t
)
]
= FE(
t1
t1
)F
+ E(v
t
v
t
)
where FE(
t1
v
t
) = 0.
= FF
+Q
vec() = vec(FF
) + vec(Q)
vec() = vec(FF
) + vec(Q)
vec() = (F F)vec() + vec(Q)
= [I
(Np)
2 (F F)]
1
vec(Q)
The eigenvalues of (F F) are all of the form
j
j
where
i
and
j
are eigenvalues of F. Since |
i
| < 1, i, it follows that all eigenvalues
of (F F) are inside the unit circle |I
(Np)
2 (F F)| = 0.
The j -th autocovariance of
t
is
E[
t
tj
] = FE[
t1
tj
] + E[v
t
tj
]
j
= F
j1
j
= F
j
j = 1, 2, . . .
The j -th autocovariance of y
t
is given by the rst rows and n
columns of
j
j
=
1
j1
+ . . . +
p
jp
Maximum Likelihood Estimation
y
t
= c +
1
y
t1
+ . . . +
p
y
tp
+
t
(1)
t
i.i.d.N(0, )
(T + p) observations. Conditioning on the rst p observations we
estimate using the last T observations.
Conditional likelihood:
f
Y
T
,Y
T1
,...,Y
1
|Y
0
,...,Y
1p
(y
T
, . . . , y
1
|y
0
, . . . , y
1p
; )
= (c
, vec(
1
)
, vec(
2
)
, . . . , vec(
p
)
, vech()
y
t
|y
t1
, . . . , y
p+1
N(c +
1
y
t1
+ . . . +
p
y
tp
, )
x
t
=
_
_
1
y
t1
.
.
.
y
tp
_
_
(Np + 1) 1
_
c
1

2
. . .
p
_
(N (Np + 1))
E(y
t
|y
t1
, . . . , y
p+1
) =
x
t
f
Y
t
|Y
t1
,...,Y
1p
(y
t
|y
t1
, . . . , y
1p
; ) =
(2)
n
2
|
1
|
1
2
exp
_
1
2
(y
t
x
t
)
1
(y
t
x
t
)
_
The joint density, conditional on the y
0
, . . . , y
1p
f
Y
t
,...,Y
1
|Y
0
,...,Y
1p
(y
t
, . . . , y
1
|y
0
, . . . , y
1p
; ) = f
Y
t
|Y
t1
,...,Y
1p
()
f
Y
t1
,...,Y
1
|Y
0
,...,Y
1p
()
Recursively, the likelihood function for the full sample, conditioning
on y
0
, . . . , y
1p
, is the product of the single conditional densities:
f
Y
T
,...,Y
1
|Y
0
,...,Y
1p
=
T
t=1
f
Y
t
|Y
t1
,...,Y
1p
(y
t
|y
t1
, . . . , y
1p
; )
The log likelihood function:
L() =
TN
2
log (2)+
T
2
log |
1
|
1
2
T
t=1
_
(y
t
x
t
)
1
(y
t
x
t
)

The ML estimate of :
=
_
T
t=1
y
t
x
t
__
T
t
x
t
x
t=1
_
1
The j -th row of

is:
u
= u
j
_
T
t=1
y
t
x
t
__
T
t
x
t
x
t
_
1
This is the estimated coecient vector from an OLS regression of y
jt
on x
t
. ML estimates are found by an OLS regression of y
jt
on a
constant and p lags of all the variables in the system.
The ML estimate of is given by:
=
1
T
T
t=1
t
Asymptotic distribution of

The ML estimates

and

will give consistent estimates of the
population parameters even if the true innovations are non-gaussian:
(L)y
t
=
t
t
i.i.d.(0, )
E[
it
jt
lt
mt
] < i, j, l, m
the roots of
|I
N

1
z . . .
p
z
p
| = 0
Let K N p + 1, x
t
(1 K):
x
t
= [1 , y
t
, y
t1
, . . . , y
tp
]

T
= vec(
T
)

T
=
_
_

1,T
.
.
.

N,T
_
_

i,t
=
_
t
x
t
x
t
_
1
_
t
x
t
y
it
_
T
=
1
T
it
= y
it
x
t

i,T
Then,
1
T
t
x
t
x
t
p
Q = E (x
t
x
t
)

T
p
T
p
T(
T
)
d
N(0, (Q
1
))
T(
i,T
)
d
N(0, (
2
i
Q
1
))
2
i
= E(
2
it
)

2
i
=
1
T
2
it
p
2
i

i
N
_
_
i
,
2
i
_
t
x
t
x
t
_
1
_
_
OLS t and F statistics applied to the coecients of any single
equation in the VAR are asymptotically valid. A more general
hypothesis
R = d
can be tested using a generalization of the Wald form of the OLS
2
test
T(R
T
d)
d
N
_
0, R
_
Q
1
_
R
_
2
(m) = T(R
T
d)
_
R
_
T

Q
1
T
_
R
_
1
(R
T
d)
= (R
T
d)
_
R
_
T
(T

Q
T
)
1
_
R
_
1
(R
T
d)
= (R
T
d)
_
_
R
_
_
T

_
t
x
t
x
t
_
1
_
_
R
_
_
1
(R
T
d)

Rossi VAR PHD PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Rossi VAR PHD PDF

Uploaded by

Copyright:

Available Formats

Universit`a di Pavia

Vector AutoRegression Model

Eduardo Rossi c - Time Series Econometrics 11 28

You might also like