Assignment 2

IBM shares’ closing price are believed to be random. Table 13.6 contains 687 observations of daily
closing share price of IBM on five days a week.

Graphical Analysis
Time series of log of closing share price
Figure 1 shows the log of the closing daily prices of the stock plotted against time. We can observe a
vague trend in the plotted data. Moreover, mean of LCLOASE varies in different sections of the
series. This violates a condition of stationarity.

Figure 1 Line graph of log of close

Figure 2 shows log of closing price of IBM stock (LCLOSE) at a given period of time plotted against the
log of stock price lagged one day (LCLOSE_1). Very strong positive correlation between LCLOSE and
LCLOSE_1 can be observed in the Figure 2. This means that LCLOSE has a strong autocorrelation with
one day lag values. Hence, there are symptoms that LCLOSE is a non-stationary time series.

Figure 2 scatter diagram of lclose and lclose_1

Correlogram
Table 1 Auto correlation

Autocorrelation in the Table 1 starts with a very high value at one day lag (i.e. 0.981). The AC drops
gradually at a diminishing rate up to 36 days lag which shows that LCLOSE time series in non-
stationary. Moreover, Q-statistics are quite high overall and p<0.001. There is a very strong evidence
to reject the null hypothesis that LCLOSE time series is stationary. Hence, LCLOSE is a non-stationary
time series.

Unit root analysis

Dickey-Fuller Test
Table 2 Dickey-Fuller Test

We now apply Dickey-Fully Test to analyse the stationarity of the LCLOSE time series. For this reason,
we have regressed first differential of the LCLOSE (i.e. DLCLOSE) with respect to TIME and LCLOSE_1.
The regression results show that there is a strong evidence that TIME and LCLOSE_1 bring about
statistically significant changes in the DLCLOSE. The t-statistic in the table shows calculated tau
values. The DF critical values are: –3.9619 (1% level), –3.4117 (5% level) and –3.1277 (10% level). The
absolute calculated TAU value for LCLOSE_1 is les than the absolute critical values. Hence, we
conclude that the DLCLOSE is not stationary.

Augmented Dickey-Fuller Test

Table 3 Augmented Dickey-Fuller Test at level

Table 3 shows the Augmented Dickey-Fuller test at level. The t-statistic value us smaller that the
critical values at 1%, 5% and 10% level and p>0.1. There is a very strong evidence to retain the null
hypothesis that LCLOSE has a unit root. In other words, LCLOSE is not stationary.
Difference Stationary Process (DSP)
Table 4 Augmented Dickey-Fuller Test at first differential

In order to find out is the LCLOSE series is difference stationary, we conducted the Augmented
Dickey-Fuller Test at first difference. The t-statistic is grater than critical values at all levels and p is
close to zero. Hence, there is a very strong evidence to reject the null hypothesis that first
differential of the LCLOSE has a unit root. In other words, we can conclude that first difference of
LCLOSE is stationary series.

A time series is known to be Difference Stationary if its first difference series is nonstationary. The
Figure 3 reinforces this conclusion as a constant mean of DLNCLOSE can be observed.

Figure 3 Line Graph of DLCLOSE

Time stationary process (TSP)
Table 5 LNCLOSE Regressed wrt Time

In order to analyse whether LCLOSE is time stationary, we regressed LNCLOSE (log of CLOSE) with
respect to time. R-sq shows that 40.47% of the variations in the LNCLOSE can be explained by the
variations in TIME. It is statistically significant variable in the regression equation with t(686)=
-21.58967, p<0.001.

Error term of such a regression is detrended time series of a variable. In EViews, we generated ERR
to capture the error term to this regression. Hence, ERR is detrended LCLOSE. Line-graph of ERR
shows that the mean of the series is not constant violating a condition of stationarity.

Figure 4 detrended LNCLOSE (ERR) Series

Table 6

Table 6 shows Augmented Dickey-Fuller Test of ERR (the detrended LCLOSE). The t-statistic value is
smaller than the critical values at 1%, 5% and 10% level and p>0.1. There is a very strong evidence to
retain the null hypothesis that ERR has a unit root. In other words, LCLOSE is not time stationary
series.