Economics, auth EXERCISES Questions 1, Simatannar- Equation 22 Ti ie tw Models sonoma Frcariog Comparo208 CHAPTER TWENTY-TWO; TIME SERIES ECONOMETRICS: FORECASTING 865 b. In VAR modeling the value of a variable is expressed as a linear func tion of the past, or lagged, values of that variable and all other variables in- cluded in the model. . Ifcach equation contains the same number of lagged variables in the system, it can be estimated by OLS without resorting to any systems method, such as two-stage least squares (2SLS) or seemingly unrelated re~ gressions (SURE). d. This simplicity of VAR modeling may be its drawback. In view of the limited number of observations that are generally available in most eco- nomic analyses, introduction of several lags of each variable can consume a lot of degrees of freedom.” e. If there are several lags in each equation, it is not always easy to in- terpret each coefficient, especially if the signs of the coefficients alternate. For this reason one examines the impulse response function (IRF) in VAR modeling to find out how the dependent variable responds to a shock ad- ministered to one or more equations in the system. £. There is considerable debate and controversy about the superiority of the various forecasting methods. Single-equation, simultaneous-equation, ‘Box-Jenkins, and VAR methods of forecasting have their admirers as well as detractors. All one can say is that there is no single method that will suit all situations. If that were the case, there would be no need for discussing the various alternatives. One thing is sure: The Box-Jenkins and VAR method- ologies have now become an integral part of econometrics. 4, We also considered in this chapter a special class of models, ARCH. and GARCH, which are especially useful in analyzing financial time series, such as stock prices, inflation rates, and exchange rates. A distinguishing feature of these models is that the error variance may be correlated over time because of the phenomenon of volatility clustering, In this connection, we also pointed out that in many cases a significant Durbin-Watson d may in fact be due to the ARCH or GARCH effect. 22.1, What are the major methods of economic forecasting? 22.2, What are the major differences between simultaneous-equation and Box-Jenkins approaches to economic forecasting? 22.3. Outline the major steps involved in the application of the Box-Jenkins approach to forecasting, 22.4, What happens if Box-Jenkins techniques are applied to time series that are nonstationary? "Followers of Bayesian statistics believe that R_Litterman,"A Statistical Approach to Economie Fos rome Staistis, vol. 4, 1986, pp. 1 his problem can be minimized. See sting," Journal of Business and FeoEconomics, auth 1, Siatanenur-Equnton | 22 Ta Models sonoma Frcariog Cran 208 868 PARTFOUR: SMULTANEOUS-EQUATION MODELS Problems 22.5. 22.6. 22.7. 22.8. 2.9. 22.10, 22.11. 22.12. 22.13. 22.14. 22.15. 22.16. 22.17. “22.18, "22.19. 22.20, 22.21. 22.22, 22.23. What are the differences between BoxJenkins and VAR approaches to economic forecasting? In what sense is VAR atheoretic? “If the primary object is forecasting, VAR will do the job.” Critically eval- uuate this statement, Since the number of lags to be introduced in a VAR model can be a sub- jective question, how does one decide how many lags to introduce in a concrete application? Comment on this statement: “Box—Jenkins and VAR are prime examples of measurement without theory.” What is the connection, if any, between Granger causality tests and VAR modeling? Consider the data on PDI (personal disposable income) given in Table 21.1. Suppose you want to fit a suitable ARIMA model to these data, Outline the steps involved in carrying out this task. Repeat exercise 22.11 for the PCE (peisonal consumption expenditure) data given in Table 21.1 Repeat exercise 22.11 for the profits data given in Table 21.1 Repeat exercise 22.11 for the dividends data given in Table 21.1 In Section 13.9 you were introduced to the Schwarz criterion to deter mine lag length. How would you use this criterion to determine the ap. propriate lag length in a VAR model? Using the data on PCE and PDI given in Table 21.1, develop a bivariate VAR model for the period 1970-1 to 1990-1V. Use this model to forecast the values of these variables for the four quarters of 1991 and compare the forecast values with the actual values given in Table 21.1 Repeat exercise 22.16, using the data on dividends and profits Refer to any statistical package and estimate the impulse response func tion for a period of up to 8 lags for the VAR model that you developed in exercise 22.16 Repeat exercise 22.18 for the VAR model that you developed in exercise 22.17. Refer to the VAR regression results given in Table 22.4. From the various F tests reported in the three regressions given there, what can you say about the nature of causality in the three variables? Continuing with exercise 20.20, can you guess why the authors chose to express the three variables in the model in percentage change form rather than the levels of these variables? (Hint: Stationarity:) Using the Canadian data given in Table 17.3, find out if My and R are stationary random variables? If not, are they cointegrated? Show the necessary calculations. Continue with the data given in Table 17.3, Now consider the following, simple model of money demand in Canada! In My, = By + Br In GDP, + pin R + OptionalGujrat Baie 1, Siataonsr-Equnon [ 22. Tin ie tw conometics Fourth Mode sonoma Frcariog Comparo208 CHAPTER TWENTY-TWO; TIME SERIES ECONOMETRICS: FORECASTING 867 a. How would you interpret the parameters of this model? b. Obtain the residuals from this model and find out if there is any ARCH effect, 22.24, Refer to the ARCH(3) model given in (22.11.4). Using the same data we estimated the following ARCH(1) model: 0.00000078 + 0.3737 1= (7.5843) (10.2351) R= 0.1397 d= 1.9896 How would you choose between the two models? Show the necessary calculations.