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You are on page 1of 24

and is the number of

observations.

(2) Define the population correlation coefficient and explain why it is bounded by

the values 1 and +1.

(3) Assume we have a two-asset portfolio, where the return on the portfolio, RP, is

the sum of the product of the return on each asset, R 1 and R2, multiplied their

proportionate share (weight) in the portfolio, W1 and W2, respectively. That is:

RP = W1R1 + W2R2,

Where, W1 + W2 = 1.

(b) Define the variance of the return on this portfolio and show that:

p2 = W1212 + 2W1W212 + W2222

Where p2 denotes the variance of the return on the portfolio, 12 is the

variance of the return on asset 1, 22 is the variance of the return on asset 2

and 12 is the covariance of the returns on assets 1 and 2.

(c) Modify the expression of the portfolios variance derived in (3)(b) such that

the portfolios standard deviation is a function of the correlation coefficient

between assets 1 and 2.

(1)

State whether the following statements are true, false, or uncertain. Justify

your answers.1

(a)

(b)

(2)

The following random sample was obtained from a normal population with

mean and variance = 2.

8, 9, 6, 13, 11, 8, 12, 5, 4, 14

(a)

(b)

(3)

Test = 5 against > 5. Use = 0.05.

(a)

(b)

(4)

A type II error occurs when we reject the null hypothesis even though it

may be true.

As the degrees of freedom increase indefinitely, the t distribution

approaches the normal distribution.

an exceptionally high positive correlation.

A variable can have a positive or negative variance.

In a random sample of rents (X, in s per week) for superior rooms in a leafy

suburb of London the following information was gathered:

n = 40

(a)

(b)

(c)

(d)

( X i X ) 2 = 5900

Xi = 7200

Construct a 95% and 99% confidence interval for the mean value of rents.

Test the hypothesis, at the 5% and 1% levels, that the true mean is 175.5.

Use both a one tailed (greater than) and 2 tailed test. Comment on the

inference drawn.

Why would a larger sample be useful?

Explain why the t table was needed.

(1)

(a)

stochastic Population Regression Function (PRF) for the demand of a good

represented by the function: = (), where denotes the quantity

demanded of a good and is the price of that good.

Q = f(P)

(5.1.1)

(b)

the PRF specified in (a)?

(c)

Specify the stochastic model that can be estimated from a sample of data,

called the stochastic Sample Regression Function (SRF).

(d)

part (c); this is called the Sample regression Line (SRL).

(e)

denotes consumption in time period and denotes income in time

period :

(i)

represents the stochastic PRF for this relationship.

(ii) Write down the two-variable linear mathematical equation that

represents the stochastic SRF for this relationship.

(iii) Explain what slope coefficient represents and comment on any

expectations based upon economic theory that you may have about

its value.

estimators)

(1)

Showing all the steps of your derivation, derive OLS estimators 1 and 2 for

the following two-variable SRF:

= 1 + 2 +

(7.1.1)

(1)

= 1 + 2 +

(8.1.1)

where denotes the natural logarithm of the exchange rate between two

countries (number of units of foreign currency per US $) and is the natural

logarithm of the ratio of the foreign price to the domestic (USA) price.

Summary statistics of the data are given below for three country pairings:

Canada and the USA (denoted Canada), Denmark and the USA (Denmark) and

Japan and the USA (Japan).

Canada

2

2

=1 = 0.66939,

=1 =

2

2

0.072624, =1 = 0.09434, =1 = 0.08353, =1 = 0.54685.

Denmark

2

2

=1 = 1.07190,

=1 =

2

2

0.24558,

=1 = 0.07825, =1 = 0.25668, =1 = 1.04697.

Japan

2

2

= 35, = 5.13374, = 0.25906,

=1 = 5.81281, =1 = 1.43787,

2

2

(a)

all 3 country parings:

1 = 2

(8.1.2)

2 = =1

2

(8.1.3)

=1

where, =

=1

, =

=1

, = and = .

(b)

effects for all 3 country pairings.

(c)

Theory suggests that an increase in the relative price should raise the

exchange rate. Given this theoretical expectation, comment on whether

for all 3 country pairings.

(d)

Specify the formula for the regression standard error (), numerically

calculate it and interpret the result for all 3 country parings.

(e)

standard errors of (8.1.1) for all 3 country parings:

2

1 = 2 ( =1

2

=1

2 = 2 (

2

=1

(2)

(8.1.4)

(8.1.5)

= 1 + 2 +

(8.2.1)

where denotes USA total real consumer personal expenditure and is USA

real personal disposable income (both measured in $billions with 2009 as the

base year).

You are given the following annual data on these series from 2010 2013.

Ct

2010

2011

2012

2013

3309.2

3414.7

3515.8

3641.6

Yt

11055.1

11331.2

11676.2

11650.8

(a)

(b)

version of (8.2.1) when income ( ) is:

(i)

(ii)

(c)

$10000 billion

$12000 billion

Calculate , 1 and 2 .

(1)

Showing all the steps of your derivation, demonstrate that the OLS estimator

for the slope coefficient, 2, in the SRF given by (10.2.1) is unbiased given that

the assumptions about the LRM hold. Clearly state the assumptions that are

used in your derivation.

= 1 + 2 +

(12.1.1a)

An econometrician is analysing the following population regression function:

= 1 + 2 2 + 3 3 +

(1)

where denotes the natural logarithm of the exchange rate between two countries

(number of units of foreign currency per US $), 2 is the natural logarithm of the

foreign price and 3 is the natural logarithm of the domestic (USA) price.

Summary statistics of the data are given below for three country pairings: Canada

and the USA (denoted Canada), Denmark and the USA (Denmark) and Japan and the

USA (Japan).

Canada

2

= 35, = 0.21224, 2 = 4.09883, 3 = 4.08118,

=1 = 0.66939,

2

2

=1 3 = 2.03196, =1 2 3 = 8.89466,

=1 = 0.17165.

Denmark

2

= 35, = 1.90136, 2 = 4.06337, 3 = 4.08118,

=1 = 1.07190,

2

Japan

2

= 35, = 5.13374, 2 = 4.34024, 3 = 4.08118,

=1 = 5.81281,

2

(a)

Use the following formula to produce coefficient estimates of (1) for all 3

country parings:

1 = 2 2 3 3

(2)

=1 3 =1 2 3 =1 3

2 = =1 2

2

(3)

=1 2 =1 3 (=1 2 3 )

=1 2 =1 2 3 =1 2

3 = =1 3

2

(4)

=1 2 =1 3 (=1 2 3 )

where, = =1

, 2 =

3 = 3 3.

=1 2

, 3 =

=1 3

, = , 2 = 2 2 and

(b)

Interpret the coefficients estimated in (a) in terms of their marginal effects for

all 3 country pairings.

(c)

Theory suggests that an increase in the foreign price should raise the exchange

rate and a rise in the domestic price should reduce the exchange rate. Given

these theoretical expectations comment on whether the coefficients estimated

in (a) are consistent with economic theory for all 3 country pairings.

(d)

Specify the formula for the regression standard error (), numerically calculate

it and interpret the result for all 3 country parings.

(e)

errors of (1) for all 3 country parings:

1

1 = +

2

2

2

22

=1 3 +3 =1 2 22 3 =1 2 3

2

=1 2 =1 3 (=1 2 3 )

=1 3

2

2

=1 2 =1 3 (

=1 2 3 )

2 =

3 =

=1 2

=1 2 =1 3 (=1 2 3 )

(5)

(6)

(7)

Econometrics exercises 15 and 17: hypothesis testing and fit in the K-variable LRM

An econometrician is analysing the following population regression function:

= 1 + 2 2 + 3 3 +

(1)

where denotes the natural logarithm of the exchange rate between two countries,

2 is the natural logarithm of the foreign price and 3 is the natural logarithm of

the domestic (USA) price.

The table below summarises estimation results for three country pairings: Canada

and the USA (denoted Canada), Denmark and the USA (Denmark) and Japan and the

USA (Japan).

1

2

3

RSS

TSS

N

Canada

-0.857380

(0.125851)

-0.406750

(0.339787)

0.670598

(0.359609)

0.171645

0.669394

35

Denmark

2.016043

(0.407449)

0.436806

(0.571783)

-0.463000

(0.649971)

1.044620

1.071901

35

Japan

7.765857

(0.469544)

0.304484

(0.245288)

-0.968750

(0.167731)

0.763833

5.812811

35

RSS denotes the residual sum of squares ( 2 ), TSS the total sum of squares ( 2 )

and N the number of observations.

(1) Purchasing Power Parity (PPP) theory suggests that 2 > 0 and 3 < 0.

Comment on whether the estimated coefficients are consistent with these

theoretical expectations. How would you use information on the coefficients

statistical significance to modify this assessment of consistency with theory?

(2) For each country pairing test whether each of the coefficients are statistically

significant using a two-tailed test and a 5% level of significance. That is, test the

null hypothesis 0 : = 0 against the alternative 1 : 0, where k = 1, 2, 3.

Interpret the test results.

(3) Calculate 2 , 2 and s for each country pairing and interpret the results.

(4) Using a 5% level of significance test, for each country pairing, whether the

regression has significant explanatory power by testing the null hypothesis

0 : 2 = 0 against the alternative 1 : 2 > 0. Interpret the test results.

(5) Impose the restriction 3 = 2 on the unrestricted model, equation (1), to

derive the resulting restricted model.

(6) For each country pairing use the F-statistic to test the symmetry restriction with

a 5% level of significance. That is, test the null hypothesis 0 : 3 = 2 against

the alternative 1 : 3 2. Note that the restricted residual sum of squares

(RRSS) for Canada is 0.5468, for Denmark is 1.0470 and for Japan is 1.7896.

Interpret the test results.

PPP using EViews

Our aim is to estimate the 3-variable and 2-variable PPP LRM using E-Views. This will

involve transferring PPP data from Excel to EViews and estimating the unrestricted

and relative price versions of the PPP statistical model.

These notes are organised as follows. Section 16.1 discusses the models to be

analysed, section 16.2 outlines the transfer of data from Excel to E-Views, working in

E-Views is discussed in section 16.3 and saving the E-Views results in a Word file is

outlined in section 16.4.

As with the previous exercises the $/ exchange rate (EA or Et) data is modelled

using US (CPA or FPt) and UK (CPU or Pt) consumer price indices, 1990~100, following

the PPP hypothesis. This exercise will focus on versions of the relative price form of

PPP. The relative price form and unrestricted form of PPP are:

Unrestricted form:

(16.1.1b)

Defining the variables and coefficients as: Yt = lnEt, Xt = ln(FPt / Pt), = , and =

, this can be re-expressed using the following standard two-variable LRM form:

Relative price form:

(16.1.1b)

This section outlines the procedure for transferring the variables EA, CPU and CPA

from the Excel file Exercise_16_EC5002_PPP_data.xls to E-Views and saving data in

an E-Views format file. Where EA denotes the UK sterling to US dollar exchange rate

(number of dollars per pound), CPA is the US consumer price index and CPU is the

consumer price index for the UK.

(1) Go on to EC5002 area on StudySpace and open the Excel data file called

Exercise_16_EC5002_PPP_data.xls.

(2) To copy the variables, EA, CPU and CPA, with their labels to the clipboard,

highlight the cell range B1:D26 and copy the selection for example, click on

the Edit menu and choose the Copy option.

(3) Open the E-Views program (you must have loaded this program from the

Kingston University Service Store to your work area). It is opened in different

ways in different labs in the University.

(4) To create a new E-Views workfile when in E-Views, click on the File menu and

(5) To specify the data frequency and period for the workfile, in the dialog box that

appears on the screen choose the (default) Frequency of data to be annual,

specify the Start date to be 1970 and the End date to be 1994, then click on OK.

The new workfile object should appear on the screen.

(6) To begin the transfer of the data saved in Excel to the E-Views workfile click on

the Quick menu at the very top of the screen and select the Empty Group (Edit

Series) option a spreadsheet should appear.

(7) To provide space for the variables titles press the arrow up button () on the

keyboard a second row with the title Obs should appear.

(8) To paste the data currently saved on the clipboard into E-Views click on the Edit

menu situated at the very top of the screen (do not click on the Edit +/ menu

at the top of the workfile object box) and select the Paste option. The PPP data

should now appear in the spreadsheet.

(9) To close the spreadsheet view of the data click on the situated at the top right

of the workfile object box (do not click on the situated at the top right of the

screen as this will initiate the closure of E-Views). Respond Yes when asked if

you wish to Delete Untitled Group. The workfile object box should now

include icons for the three series objects: cpa, cpu and ea.

(10) To save the transferred data click on the Save menu at the top of the workfile

object box, specify the filename for the workfile to be Exercise_16_EC5002,

select the appropriate drive and then click on the Save button. Note that the

extension for the E-Views workfile is wf1 (so your workfile is called

Exercise_16_EC5002_PPP_data.wf1).

This section outlines the use of E-Views for transforming variables, running a

regression and saving the results in Word.

16.3.1 Transforming and saving data

(1) To generate transformed variables (the natural logarithms), type the following

commands on the command line (the blank area at the top of the screen):

GENR LEA=LOG(EA) and then press the Enter button on the keyboard,

GENR LCPU=LOG(CPU) and then press the Enter,

GENR LCPA=LOG(CPA) and then press the Enter,

GENR LRPA=LCPALCPU and then press the Enter.

(2) To save the updated workfile click on the Save option at the top of the workfile

object box.

16.3.2 Estimating the PPP LRMs and saving the results in Word

(1) To estimate the 2-variable regression, (16.1.1a), click on the Quick menu and

2

When you first open EViews you can select the Create a new EViews workfile option that

automatically appears on the screen and then browse for the file that you wish to open.

10

LEA C LRPA in the large blank area in the dialog box that appears and click on

the OK button. Note that the term C represents the intercept in the regression.

(2) The following output should have appeared on the screen.3

(3) This output can be saved in a Word file in the following way. Highlight the

output to be saved (highlight all of the output) and copy this to the clipboard

(for example, use the Edit and Copy menus). Open the Word program and paste

the output into Word (for example, use the Edit and Paste menus). Return to

EViews (for example, click on the EViews button at the bottom of the screen).

Dependent Variable: LEA

Method: Least Squares

Sample: 1970 1994

Included observations: 25

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA

0.465626

0.670174

0.034621

0.108971

13.44909

6.150034

0.0000

0.0000

R-squared

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.621853

0.605412

0.123837

0.352719

17.78853

37.82292

0.000003

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

0.614403

0.197142

-1.263082

-1.165572

-1.236037

0.612162

(4) To save the equation as an object click on the Object button (the third button

from the left at the top of the dialog box), select Name from the menu that

appears, type in the name of the equation in the area below the title Name to

identify object as ppp_2_lrm and click on the OK button.

(5) To close the dialog box with the estimation results click on the situated at the

top right of the equation objects dialog box. An equation object should now

appear in the workfile as = ppp_2_lrm.

(6) To estimate the 3-variable regression, (16.1.1b), double click on the equation

object, = ppp_2_lrm.

(7) Click on the Object button and select Copy object from the menu that

appears. In the new object dialog box that appears click on the Object button,

select Name from the menu that appears, type in the name of the equation in

the area below the title Name to identify object as ppp_3_lrm and click on the

OK button.

(8) Click on the Estimate button situated as seventh from the left on the menu bar

at the top of the object dialog box. Type the equation to be estimated as LEA C

LCPA LCPU in the large blank area in the dialog box that appears and click on the

OK button.

(9) The following output should have appeared on the screen.

(10) This output can be added to the Word file by highlighting and copying the

output to be saved and pasting it into Word. Return to EViews (for example,

3

11

Dependent Variable: LEA

Method: Least Squares

Sample: 1970 1994

Included observations: 25

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LCPA

LCPU

0.937511

0.375168

-0.478546

1.040684

0.659616

0.436688

0.900860

0.568767

-1.095853

0.3774

0.5753

0.2850

R-squared

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.625358

0.591300

0.126032

0.349449

17.90494

18.36139

0.000020

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

0.614403

0.197142

-1.192395

-1.046130

-1.151828

0.622585

(11) To close both of the dialog boxes containing the estimation results click on the

situated at the top right of both of the equation objects dialog boxes. Another

equation object should appear in the workfile as = ppp_3_lrm.

(12) To save the updated workfile click on the Save option at the top of the workfile

object box.

(13) To exit E-Views, click on the File menu, choose Exit and click on OK when told

that all unsaved data will be lost (you have already saved your data in

Exercise_16_EC5002_PPP_data.wf1).

16.4 Saving the E-Views results (computer output) in a Word file

(1) To save the EViews computer output that you pasted in to the Word document

Exercise_16_EC5002 click on the File menu, choose the Save As option and

select the Word Document option in the Save as type: area, type in the name of

the document as Exercise_16_EC5002 and navigate to the drive where you want

to save the file. Click on Save.

(2) Exit Word (shut down Excel if necessary) and shut down the computer.

12

Our aim is to test whether the estimates of the 2-variable relative price form of the

PPP model are valid using E-Views. This will involve testing whether the assumption

that the linear regression models (LRM) residuals from evident serial correlation

(autocorrelation). An autoregressive distributed lag (ADL) model that overcomes

autocorrelation will also be estimated.

19.1 Working in E-Views

This section outlines the use of E-Views for running a static regression, testing for

autocorrelation, overcoming autocorrelation using an ADL model, estimating a

parsimonious ADL model and saving the results in a Word document.

19.2 Open a workfile, open the existing 2-variable PPP LRM model and save the

results

(1) Enter Eviews and load the workfile Exercise_16_EC5002_PPP_data.wf1 that was

saved in the previous exercise. That is, click on the File menu, and select the

option

Open

followed

by

Workfile,

choose

the

file

4

Exercise_16_EC5002_PPP_data.wf1 and click on the Open button.

(2) To apply autocorrelation tests to the 2-variable PPP LRM open the object where

this equations estimation results are stored by double clicking on the equation

object, = ppp_2_lrm. The following output should have appeared on the

screen.5 Identify the DW statistic that tests for first-order autocorrelation on this

output.

Method: Least Squares

Sample: 1970 1994

Included observations: 25

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA

0.465626

0.670174

0.034621

0.108971

13.44909

6.150034

0.0000

0.0000

R-squared

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.621853

0.605412

0.123837

0.352719

17.78853

37.82292

0.000003

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

0.614403

0.197142

-1.263082

-1.165572

-1.236037

0.612162

(3) This output can be saved in a Word file in the following way. Highlight the

4

When you first open EViews you can select the Open an existing EViews file option that

automatically appears on the screen and then browse for the file that you wish to open.

5

Do not worry if there are minor discrepancies with your results.

13

output to be saved (highlight all of the output) and copy this to the clipboard

(for example, use the Edit and Copy menus). Go to the desktop, open the Word

program and paste the output into Word (for example, use the Edit and Paste

menus). Return to EViews (for example, click on the EViews button at the

bottom of the screen).

19.3 Testing the estimated LRM for 1st-order autocorrelation using the BreuschGodfrey test

(1) To test the estimated PPP LRM for 1storder autocorrelation, click on the View

menu, select the option Residual Tests and then choose Serial Correlation LM

Test. When prompted to specify the Lags to include type 1 and click on the OK

button.

(2) This output can be added to the Word file by highlighting and copying the

output to be saved and pasting it into Word. Return to EViews (for example,

click on the EViews button at the bottom of the screen). The following output

should have appeared on the screen.6 Is there evidence of first-order

autocorrelation?

Breusch-Godfrey Serial Correlation LM Test:

F-statistic

Obs*R-squared

19.77152

11.83313

Prob. F(1,22)

Prob. Chi-Square(1)

0.0002

0.0006

Test Equation:

Dependent Variable: RESID

Method: Least Squares

Sample: 1970 1994

Included observations: 25

Presample missing value lagged residuals set to zero.

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA

RESID(-1)

-0.002141

0.005485

0.689207

0.025695

0.080869

0.154999

-0.083321

0.067825

4.446518

0.9343

0.9465

0.0002

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.473325

0.425446

0.091891

0.185768

25.80319

9.885761

0.000865

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

14

7.05E-17

0.121230

-1.824255

-1.677990

-1.783687

1.268535

19.4 Testing the estimated LRM for 2nd-order autocorrelation using the BreuschGodfrey test

(1) To test the estimated PPP LRM for 2ndorder autocorrelation, click on the View

menu, select the option Residual Tests and then choose Serial Correlation LM

Test. When prompted to specify the Lags to include type 2 and click on the OK

button. Is there evidence of second-order autocorrelation?

Breusch-Godfrey Serial Correlation LM Test:

F-statistic

Obs*R-squared

16.76415

15.37197

Prob. F(2,21)

Prob. Chi-Square(2)

0.0000

0.0005

Test Equation:

Dependent Variable: RESID

Method: Least Squares

Sample: 1970 1994

Included observations: 25

Presample missing value lagged residuals set to zero.

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA

RESID(-1)

RESID(-2)

0.001521

-0.005002

1.045375

-0.521439

0.022528

0.070881

0.186652

0.187686

0.067500

-0.070568

5.600651

-2.778250

0.9468

0.9444

0.0000

0.0113

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.614879

0.559862

0.080427

0.135839

29.71600

11.17610

0.000136

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

7.05E-17

0.121230

-2.057280

-1.862260

-2.003190

2.278805

(2) To save the output that appears on the screen (above) in Word, highlight and

copy the output to be saved and paste it into Word. Return to EViews (for

example, click on the EViews button at the bottom of the screen).

(3) To close the dialog box containing the estimation results click on the situated

at the top right of the equation objects dialog box.

(1) To estimate the regression Yt = 0+ 0Xt+ 1Xt1+ 2Xt2 + 1Yt1 + 2Yt2 +

ut, click on the Quick menu and select the option Estimate Equation. Type the

equation to be estimated as LEA C LRPA LRPA(1) LRPA(2) LEA(1) LEA(2) in

the large blank area in the dialog box that appears and click on the OK button.

(2) Click on the button Name at the top of the dialog box containing the estimation

results and type PPP_ADL_general, this creates an equation object in the

workfile.

(3) This output can be added to the Word file by highlighting and copying the

15

output to be saved and pasting it into Word. Return to EViews (for example,

click on the EViews button at the bottom of the screen).

Dependent Variable: LEA

Method: Least Squares

Sample (adjusted): 1972 1994

Included observations: 23 after adjustments

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA

LRPA(-1)

LRPA(-2)

LEA(-1)

LEA(-2)

0.227545

-0.048926

0.660527

-0.304550

1.089954

-0.569411

0.077462

0.777823

1.229136

0.694393

0.200017

0.201803

2.937500

-0.062902

0.537392

-0.438585

5.449296

-2.821616

0.0092

0.9506

0.5980

0.6665

0.0000

0.0118

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.845040

0.799463

0.084044

0.120076

27.79831

18.54109

0.000002

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

0.590984

0.187675

-1.895506

-1.599290

-1.821008

2.079239

F-statistic

Obs*R-squared

0.308463

0.435029

Prob. F(1,16)

Prob. Chi-Square(1)

0.5863

0.5095

Test Equation:

Dependent Variable: RESID

Method: Least Squares

Sample: 1972 1994

Included observations: 23

Presample missing value lagged residuals set to zero.

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA

LRPA(-1)

LRPA(-2)

LEA(-1)

LEA(-2)

RESID(-1)

-0.030439

0.189730

-0.389966

0.167270

0.177906

-0.114000

-0.279803

0.096221

0.864501

1.437999

0.770281

0.379882

0.290831

0.503792

-0.316343

0.219468

-0.271186

0.217154

0.468319

-0.391980

-0.555395

0.7558

0.8291

0.7897

0.8308

0.6459

0.7002

0.5863

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.018914

-0.348993

0.085807

0.117805

28.01791

0.051411

0.999265

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

16

-2.55E-16

0.073878

-1.827645

-1.482059

-1.740731

1.932099

(1) To test the estimated ADL PPP LRM for 1storder autocorrelation, click on the

View menu, select the option Residual Tests and then choose Serial Correlation

LM Test. When prompted to specify the Lags to include type 1 and click on the

OK button.

(2) This output (above) can be added to the Word file by highlighting and copying

the output to be saved and pasting it into Word. Return to EViews (for example,

click on the EViews button at the bottom of the screen). Does this model exhibit

evident first-order autocorrelation?

(3) To test the estimated PPP LRM for 2ndorder autocorrelation, click on the View

menu, select the option Residual Tests and then choose Serial Correlation LM

Test. When prompted to specify the Lags to include type 2 and click on the OK

button.

(4) To save the output (below) that appears on the screen in Word, highlight and

copy the output to be saved and paste it into Word. Return to EViews (for

example, click on the EViews button at the bottom of the screen). Does this

model exhibit evident second-order autocorrelation?

Breusch-Godfrey Serial Correlation LM Test:

F-statistic

Obs*R-squared

0.822988

2.274269

Prob. F(2,15)

Prob. Chi-Square(2)

0.4580

0.3207

Test Equation:

Dependent Variable: RESID

Method: Least Squares

Sample: 1972 1994

Included observations: 23

Presample missing value lagged residuals set to zero.

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA

LRPA(-1)

LRPA(-2)

LEA(-1)

LEA(-2)

RESID(-1)

RESID(-2)

0.090416

0.189239

-0.611346

0.539448

-0.107589

-0.096862

0.023231

0.518455

0.141575

0.855692

1.436221

0.827866

0.450129

0.288250

0.563602

0.449367

0.638645

0.221153

-0.425663

0.651613

-0.239019

-0.336033

0.041220

1.153745

0.5327

0.8280

0.6764

0.5245

0.8143

0.7415

0.9677

0.2667

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.098881

-0.321641

0.084933

0.108203

28.99567

0.235139

0.969672

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

-2.55E-16

0.073878

-1.825711

-1.430756

-1.726381

1.946445

(1) To test whether the two variables, LRPA and LRPA(2), that appear most

individually insignificant in the ADL(2, 2), are jointly insignificant click on the

17

View menu, select the option Coefficient Diagnostics and then choose

Redundant Variables Test Likelihood Ratio. When prompted to specify the

variables to be deleted from the model type LRPA LRPA(2) in the OmittedRedundant Variable Test dialog box and then click the OK button.

(2) To save the output that appears on the screen (below) in Word, highlight and

copy the output to be saved and paste it into Word. Return to EViews (for

example, click on the EViews button at the bottom of the screen). Are the

variables LRPA and LRPA(-2) jointly insignificant? In the Restricted Test Equation

(that reports the ADL(2, 2) model with LRPA and LRPA(-2) excluded) reported in

the output below are there any further variables that might be considered for

deletion from the model?

(3) To close the dialog box containing the estimation results click on the situated

at the top right of the equation objects dialog box.

Redundant Variables Test

Equation: PPP_ADL_LEVELS_GEN

Specification: LEA C LRPA LRPA(-1) LRPA(-2) LEA(-1) LEA(-2)

Redundant Variables: LRPA LRPA(-2)

F-statistic

Likelihood ratio

Value

0.105152

0.282782

df

(2, 17)

2

Probability

0.9008

0.8681

Sum of Sq.

0.001485

0.121562

0.120076

0.120076

df

2

19

17

17

Mean

Squares

0.000743

0.006398

0.007063

0.007063

Value

27.65692

27.79831

df

19

17

F-test summary:

Test SSR

Restricted SSR

Unrestricted SSR

Unrestricted SSR

LR test summary:

Restricted LogL

Unrestricted LogL

Dependent Variable: LEA

Method: Least Squares

Sample: 1972 1994

Included observations: 23

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA(-1)

LEA(-1)

LEA(-2)

0.226558

0.293964

1.100390

-0.586239

0.073589

0.129579

0.186584

0.183547

3.078704

2.268608

5.897564

-3.193952

0.0062

0.0351

0.0000

0.0048

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.843123

0.818353

0.079987

0.121562

27.65692

34.03790

0.000000

18

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

0.590984

0.187675

-2.057124

-1.859646

-2.007459

2.181380

(1) To estimate the parsimonious regression Yt = 0+ 0Xt-1+ 1Yt1 + 2Yt2 + ut,

click on the Estimate menu and specify the equation to be estimated as LEA C

LRPA(1) LEA(1) LEA(2) in the dialog box that appears and click on the OK

button.

(2) Click on the button Name at the top of the dialog box containing the estimation

results and type PPP_ADL_specific, this creates an equation object in the

workfile.

(3) To save the output that appears on the screen in Word, highlight and copy the

output to be saved and paste it into Word. Return to EViews (for example, click

on the EViews button at the bottom of the screen).

Dependent Variable: LEA

Method: Least Squares

Sample (adjusted): 1972 1994

Included observations: 23 after adjustments

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA(-1)

LEA(-1)

LEA(-2)

0.226558

0.293964

1.100390

-0.586239

0.073589

0.129579

0.186584

0.183547

3.078704

2.268608

5.897564

-3.193952

0.0062

0.0351

0.0000

0.0048

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.843123

0.818353

0.079987

0.121562

27.65692

34.03790

0.000000

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

0.590984

0.187675

-2.057124

-1.859646

-2.007459

2.181380

(1) To test the estimated PPP LRM for 1storder autocorrelation, click on the View

menu, select the option Residual Tests and then choose Serial Correlation LM

Test. When prompted to specify the Lags to include type 1 and click on the OK

button.

(2) To save the output that appears on the screen (below) in Word, highlight and

copy the output to be saved and paste it into Word. Return to EViews (for

example, click on the EViews button at the bottom of the screen). Does this

model exhibit evident first-order autocorrelation?

19

F-statistic

Obs*R-squared

1.061349

1.280656

Prob. F(1,18)

Prob. Chi-Square(1)

0.3166

0.2578

Test Equation:

Dependent Variable: RESID

Method: Least Squares

Sample: 1972 1994

Included observations: 23

Presample missing value lagged residuals set to zero.

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA(-1)

LEA(-1)

LEA(-2)

RESID(-1)

-0.046741

-0.059805

0.288000

-0.187447

-0.441727

0.086350

0.141798

0.335933

0.258237

0.428770

-0.541299

-0.421762

0.857313

-0.725872

-1.030218

0.5949

0.6782

0.4025

0.4772

0.3166

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.055681

-0.154168

0.079859

0.114793

28.31577

0.265337

0.896369

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

-4.65E-17

0.074334

-2.027458

-1.780612

-1.965377

1.874221

(3) To test the estimated PPP LRM for 2ndorder autocorrelation, click on the View

menu, select the option Residual Tests and then choose Serial Correlation LM

Test. When prompted to specify the Lags to include type 2 and click on the OK

button.

(4) To save the output that appears on the screen in Word, highlight and copy the

output to be saved and paste it into Word. Return to EViews (for example, click

on the EViews button at the bottom of the screen). Does this model exhibit

evident second-order autocorrelation?

(5) To close the regression / test output view click on the situated at the top right

of the equation object box (do not click on the situated at the top right of the

screen as this will initiate the closure of E-Views).

20

F-statistic

Obs*R-squared

0.703920

1.759050

Prob. F(2,17)

Prob. Chi-Square(2)

0.5085

0.4150

Dependent Variable: RESID

Method: Least Squares

Sample: 1972 1994

Included observations: 23

Presample missing value lagged residuals set to zero.

Variable

Coefficient

Std. Error

t-Statistic

Prob.

C

LRPA(-1)

LEA(-1)

LEA(-2)

RESID(-1)

RESID(-2)

0.020435

0.031380

0.102049

-0.143274

-0.226462

0.255416

0.139667

0.206245

0.455156

0.272305

0.558031

0.412778

0.146310

0.152152

0.224207

-0.526154

-0.405824

0.618772

0.8854

0.8809

0.8253

0.6056

0.6899

0.5443

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.076480

-0.195143

0.081264

0.112265

28.57190

0.281568

0.916806

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

-4.65E-17

0.074334

-1.962774

-1.666558

-1.888277

1.854927

(3)

(4)

(5)

Save the updated Eviews workfile by clicking on the Save menu at the top of

the workfile dialog box and exit EViews.

Save the updated Word file containing the computer output produced and

close Word.

Logoff and/or shutdown the computer.

21

(1)

(a) Prove that the two expressions for the Durbin-Watson d-statistic (given

below) are approximately equivalent. State any necessary assumptions.

T

d = (et - et-1)

t=2

/ et2

t=1

2(1 - )

^

where et is the residual from the estimated LRM and is the estimated

autocorrelation coefficient.

(b) Using your answer to Question 1a specify the values of d that correspond

to the estimated value of being 1, 0 and 1.

the residuals exhibit statistically significant autocorrelation at the 5% level.

Assume that the residuals are from a two-variable LRM estimated using 6

observations of data.

(d) The following model is estimated where coefficient standard errors are

specified in brackets and standard statistics are given (T is the sample size):

^

Yt = 0.674 + 0.996X2t + 0.136X3t

(0.311) (0.442) (0.097)

R2 = 0.341, AdjR2 = 0.225, s = 0.1993, d = 2.403, T = 60.

Test whether the model features statistically significant first-order

autocorrelation at the 5% level. Discuss the inference that you would

draw.

autocorrelation.

22

(1)

^

Yt = 0.674 + 0.996X2t + 0.136X3t

(0.311) (0.442) (0.097)

R2 = 0.341, AdjR2 = 0.225, s = 0.1993, d = 2.403, T = 60.

The estimated residuals, et, are collected from this model and the value

preceding the first observation of the sample is set equal to zero. Using this

residual series, the following auxiliary regression is estimated over the full

sample of 60 observations:

et = 0.013 + 0.034X2t + 0.021X3t 0.032et-1 + vt

(0.062) (0.036) (0.035) (0.012)

R2 = 0.090, AdjR2 = 0.061, s = 0.0112, d = 1.983, T = 60.

Use the Breusch-Godfrey LM test to determine whether there is evidence

of statistically significant autocorrelation at the 5% level.

(b) Why is the first observation of the residual series used in Question 2a set

equal to zero?

(c) The estimated residuals, et, are collected from the model estimated in

Question 1(a) and the two values preceding the first observation of the

sample are set equal to zero. Using this residual series, the following

auxiliary regression is estimated over the full sample of 60 observations:

et = 0.011 + 0.025X2t + 0.017X3t 0.030et-1 + 0.004et-2 + vt

(0.062) (0.036) (0.035) (0.012)

(0.010)

R2 = 0.096, AdjR2 = 0.057, s = 0.0113, d = 1.897, T = 60.

Use the Breusch-Godfrey LM test to determine whether there is evidence

of statistically significant autocorrelation at the 5% level.

(d) Why are the first two values of the residual series set equal to zero?

23

(1) Assume the following two-variable LRM with AR(1) error process where is

known.

Yt X t ut

(22.1.1)

ut ut 1 vt

(22.1.2)

where, E (vt ) 0 , E (vt2 ) v2 , and E (vt vt i ) 0 . That is, vt is white noise (in

particular, non-autocorrelated).

By applying the Generalised Least Squares (GLS) estimator show that it produces BLU

coefficient estimates.

(1)

approach to overcoming autocorrelation utilises an autoregressive distributed

lag model.

(2)

Show that the following two-variable LRM with AR(1) error process is

equivalent to an ADL(1, 1) model assuming the common factor restriction holds

and specify the appropriate common factor restriction.

Yt X t ut

(23.2.1)

ut ut 1 vt

(23.2.2)

Based upon this result comment on whether the ADL(1, 1) model or twovariable LRM with AR(1) error process is more general.

24

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