Assignment 1

Economics of Forcasting & Analysis

Arjun Dua

Answer 1

Answer A

Lets start by looking at Jill’s backward iteration:

𝑦! = 𝑎" + 𝑎# 𝑦!$#

𝑦! = 𝑎" + 𝑎# (𝑎% + 𝑎# 𝑦!$& )

𝑦! = 𝑎" + 𝑎% 𝑎# + 𝑎" 𝑎#& . . . +𝑎" 𝑎#!$# + 𝑎#! 𝑦"

!$#

𝑦! = 𝑎" ( 𝑎#' + 𝑎#! 𝑦"

!("

Using sum of infinite GP with 𝑡 terms, we get

1 − 𝑎#!
𝑦! = 𝑎" + 𝑎#! 𝑦%
1 − 𝑎#

Rearranging the terms:

1 𝑎"
𝑦! = 𝑎" + 𝑎#! (𝑦" − )
1 − 𝑎# 1 − 𝑎#

Lets now look at Bill’s solution:

𝑎" 𝑎"
𝑦! = + 𝑎#! (𝑦% − )
1 − 𝑎# 1 − 𝑎#
We can see that Jill’s solution using backward iteration matches Bill’s solution. Hence they
are the same.

Answer B

Jill’s solution using backward was:

!$#

𝑦! = 𝑎% ( 𝑎#' + 𝑎#! 𝑦%
!("

At 𝑎# = 1, the above equation can be rewritten as

!$#

𝑦! = 𝑎" ( 1' + 1! 𝑦"

!("

𝑦! = 𝑎" 𝑡 + 𝑦"

Hence Proved


Bill’s Solution, for 𝑎# = 1:

Homogenous Solution:

𝑦! − 𝑎# 𝑦!$# = 0

𝑦! − 𝑦!$# = 0

Let, 𝑦! = 𝐴𝛼 !

Substituting, we get

𝐴𝛼 ! − 𝐴𝛼 !$# = 0

𝛼 = 1

⟹ 𝑦!) = 𝐴
Particular Solution:
Since the characteristic root is unity

⟹ 𝑦!* = 𝑎" 𝑡

Therefore the General Solution, can we written as follows:

𝑦! = 𝑎" 𝑡 + 𝐴

Imposing the initial condition to find A, we get

𝐴 = 𝑦" , ∵ 𝑡 = 0 & 𝑦! = 𝑦"

Therefore Bill’s solution too is

𝑦! = 𝑎" 𝑡 + 𝑦"

Answer 2

Answer A

𝑚!+# = 𝑚 + 𝜌𝑚! + 𝜖!+#

Forward Iteration :

𝑡 + 2:

𝑚!+& = 𝑚 + 𝜌(𝑚 + 𝜌𝑚! + 𝜖! ) + 𝜖!+&

⟹ 𝑚!+& = 𝑚 + 𝜌𝑚 + 𝜌& 𝑚! + 𝜌𝜖!+! + 𝜖!+&

Similarly, we can generalize for 𝑡 + ℎ:

)$# )$#

𝑚!+) = 𝑚 ( 𝜌- + 𝜌) 𝑚! + ( 𝜌- 𝜖!+)$-
-(" -("

Answer B

Taking 𝐸(𝑚!+' ) from the above equation, given 𝐸(𝜖! + 𝑖) = 0 ∀ 𝑖.

 '$#

𝐸(𝑚!+' ) = 𝑚 ( 𝜌- + 𝜌' 𝑚!
-("

#
Now as 𝑛 → ∞, ∑'$# - '
-(" 𝜌 → #$. and 𝜌 → 0

Using the above statement and sum of infinite GP, we get

𝑚
⟹ 𝐸(𝑚!+' ) =
1−𝜌

Answer 3

Answer A
i. 𝑦! = 1.5𝑦!$# − 0.5𝑦!$& + 𝜖!
Finding the homogenous solution:
𝑦! − 1.5𝑦!$# + 0.5𝑦!$& = 0
Let, 𝑦! = 𝐴𝛼 !
𝐴𝛼 ! − 1.5𝐴𝛼 !$# + 0.5𝐴𝛼 !$& = 0
𝛼 & − 1.5𝛼 + 0.5 = 0
𝛼 & − 𝛼 − 0.5𝛼 + 0.5 = 0
𝛼(𝛼 − 1) − 0.5(𝛼 − 1) = 0
(𝛼 − 0.5)(𝛼 − 1) = 0

Hence the two characteristic roots, 𝛼# = 1 & 𝛼& = 0.5

Hence the homogenous solution can be written using two arbitrary constants 𝐴# and 𝐴& as,

𝑦!) = 𝐴# + (0.5)! 𝐴&

ii. 𝑦! = 𝑦!$& + 𝜖!
Finding the homogenous solution:
𝑦! − 𝑦!$& = 0
 Let, 𝑦! = 𝐴𝛼 !
𝐴𝛼 ! − 𝐴𝛼 !$& = 0
𝛼 !$& (𝛼 & − 1) = 0
(𝛼 & − 1) = 0

Hence the two characteristic roots, 𝛼# = 1 & 𝛼& = −1

Hence the homogenous solution can be written using two arbitrary constants 𝐴# and 𝐴& as,

𝑦!) = 𝐴# + (−1)! 𝐴&

iii. 𝑦! = 2𝑦!$# − 𝑦!$& + 𝜖!

Finding the homogenous solution:
𝑦! − 2𝑦!$# + 𝑦!$& = 0
Let, 𝑦! = 𝐴𝛼 !
𝐴𝛼 ! − 2𝐴𝛼 !$# + 𝐴𝛼 !$& = 0
𝛼 & − 2𝛼 + 1 = 0
(𝛼 − 1)& = 0

Hence the two characteristic roots, 𝛼# = 1 & 𝛼& = 1

Hence the homogenous solution, since both the characteristic roots are unity, can be
written using two arbitrary constants 𝐴# and 𝐴& as,

𝑦!) = 𝐴# + 𝐴& 𝑡

iv. 𝑦! = 𝑦!$# + 0.25𝑦!$& − 0.25𝑦!$/ + 𝜖!

Finding the homogenous solution:
𝑦! − 𝑦!$# − 0.25𝑦!$& + 0.25𝑦!$/ = 0
Let, 𝑦! = 𝐴𝛼 !
𝐴𝛼 ! − 𝐴𝛼 !$# − 0.25𝐴𝛼 !$& + 0.25𝐴𝛼 !$/ = 0
𝛼 / − 𝛼 & − 0.25𝛼 + 0.25 = 0

We can verify that, one of the roots is unity

 (𝛼 − 1)(𝛼 & − 0.5) = 0

Hence the three characteristic roots, 𝛼# = 1, 𝛼& = 0.5 & 𝛼/ = −0.5

Hence the homogenous solution, since both the characteristic roots are unity, can be
written using three arbitrary constants 𝐴# , 𝐴& and 𝐴/ as,

𝑦!) = 𝐴# + 𝐴& (0.5)! + 𝐴/ (−0.5)!

Answer B
i.
𝑦! = 1.5𝑦!$# − 0.5𝑦!$& + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝑦! (1 − 1.5𝐿 + 0.5𝐿& ) = 𝜖!

𝑦! [(1 − 𝐿)(1 − 0.5𝐿)] = 𝜖!

As we can see the roots of the equation, 1 − 1.5𝐿 + 0.5𝐿& do not both lie outside the unit
root circle. Therefore the stability condition is not met. Hence solution isn’t convergent.

ii.

𝑦! = 𝑦!$& + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝑦! (1 − 𝐿& ) = 𝜖!

𝑦! [(1 − 𝐿)(1 + 𝐿)] = 𝜖!

As we can see the roots of the equation, (1 − 𝐿)(1 + 𝐿) do not lie outside the unit root
circle. Therefore the stability condition is not met. Hence solution isn’t convergent.

iii.

𝑦! = 2𝑦!$# − 𝑦!$& + 𝜖!

Rewriting the above equation in terms of lag operators, we get

 𝑦! (1 − 2𝐿 + 𝐿& ) = 𝜖!

𝑦! [(1 − 𝐿)& ] = 𝜖!

As we can see the roots of the equation, (1 − 𝐿)& are same and do not lie outside the unit
root circle. Therefore the stability condition is not met. Hence solution isn’t convergent.

iv.

𝑦! = 𝑦!$# + 0.25𝑦!$& − 0.25𝑦!$/ + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝑦! (1 − 𝐿 − 0.25𝐿& − 0.25𝐿/ ) = 𝜖!

𝑦! [(1 − 𝐿)(1 − 0.5𝐿)(1 + 0.5𝐿)] = 𝜖!

As we can see the roots of the equation, (1 − 𝐿)(1 − 0.5𝐿)(1 + 0.5𝐿) do not all lie outside
the unit root circle. Therefore the stability condition is not met. Hence solution isn’t
convergent.

Answer C

𝑦! = 1.5𝑦!$# − 0.5𝑦!$& + 𝜖!

Subtracting 𝑦!$# from both sides, we get

𝑦! − 𝑦!$# = 0.5𝑦!$# − 0.5𝑦!$& + 𝜖!

𝛥𝑦! = 0.5𝛥𝑦!$# + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝛥𝑦! (1 − 0.5𝐿) = 𝜖!

0
𝜖!
𝛥𝑦!* = = (( 0.5)- 𝜖!$-
1 − 0.5𝐿
-("
Answer D

ii.

𝑦! = 𝑦!$& + 𝜖!

Subtracting 𝑦!$# from both sides, we get

𝑦! − 𝑦!$# = 𝑦!$& − 𝑦!$# + 𝜖!

𝛥𝑦! = −𝛥𝑦!$# + 𝜖!

The first difference 𝛥𝑦! has characteristic root that is equal to -1. The proper form of the
backward-looking solution does not exist for this equation.

iii.

𝑦! −= 2𝑦!$# − 𝑦!$& + 𝜖!

Subtracting 𝑦!$# from both sides, we get

𝑦! − 𝑦!$# = 𝑦!$# − 𝑦!$& + 𝜖!

𝛥𝑦! = 𝛥𝑦!$# + 𝜖!

The first difference 𝛥𝑦! has characteristic root that is equal to unity. The proper form of the
backward-looking solution does not exist for this equation.
iv.

𝑦! = 𝑦!$# + 0.25𝑦!$& − 0.25𝑦!$/ + 𝜖!

Subtracting 𝑦!$# from both sides, we get

𝑦! − 𝑦!$# = 𝑦!$# − 𝑦!$# + 0.25𝑦!$& − 0.25𝑦!$/ + 𝜖!

𝛥𝑦! = 0.25𝛥𝑦!$& + 𝜖!

Rewriting the above equation in terms of lag operators, we get

 𝛥𝑦! (1 − 0.25𝐿& ) = 𝜖!

𝜖! 𝜖!
𝛥𝑦!* = &
=
1 − 0.5𝐿 (1 − 0.5𝐿)(1 + 0.5𝐿)

Answer E

i.

𝑦! = 1.5𝑦!$# − 0.5𝑦!$& + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝑦! (1 − 1.5𝐿 + 0.5𝐿& ) = 𝜖!

𝑦! [(1 − 𝐿)(1 − 0.5𝐿)] = 𝜖!

ii.

𝑦! = 𝑦!$& + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝑦! (1 − 𝐿& ) = 𝜖!

𝑦! [(1 − 𝐿)(1 + 𝐿)] = 𝜖!

iii.

𝑦! = 2𝑦!$# − 𝑦!$& + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝑦! (1 − 2𝐿 + 𝐿& ) = 𝜖!

𝑦! [(1 − 𝐿)& ] = 𝜖!

iv.

𝑦! = 𝑦!$# + 0.25𝑦!$& − 0.25𝑦!$/ + 𝜖!

Rewriting the above equation in terms of lag operators, we get

𝑦! (1 − 𝐿 − 0.25𝐿& − 0.25𝐿/ ) = 𝜖!

𝑦! [(1 − 𝐿)(1 − 0.5𝐿)(1 + 0.5𝐿)] = 𝜖!

Answer F

𝑦! = 𝑎" − 𝑦!$# + 𝜖!

For 𝑡 = 1,

𝑦# = 𝑎" − 𝑦" + 𝜖#

For 𝑡 = 2,

𝑦#& = 𝑦" − 𝜖# + 𝜖&

Generally, we can see that

!
𝑎"
𝑦! = (( − 1)-+! 𝜖 + (−1)! 𝑦" + (1 − (−1)! )
2
-(#

Answer 4

Answer A

𝑦! = 3 + 0.75𝑦!$# − 0.125𝑦!$& + 𝜖!

Let, 𝑦! = ( 𝑎- 𝜖!$-
-("
Equating the above equations, we get

𝛼" 𝜖! + 𝛼# 𝜖!$# . . . . . = 0.75[𝛼" 𝜖!$# + 𝛼# 𝜖!$& . . . ] − 0.125[𝛼" 𝜖!$& + 𝛼# 𝜖!$/ . . . ] + 𝜖!

(𝛼" − 1)𝜖! + (𝛼# − 0.75𝛼" )𝜖!$# + (𝛼& − 0.75𝛼# + 0.125𝛼" )𝜖!$& . . . ..

Each of these conditions but hold true, therefore

𝛼" − 1 = 0 ⟹ 𝛼" = 1

𝛼# − 0.75𝛼" = 0 ⟹ 𝛼# = 0.75

𝛼- = 0.75𝛼-$# − 0.125𝛼-$&

Solving the equation:

𝐿𝑒𝑡 𝛼- = 𝐴𝑐 -

Substituting,

𝐴𝑐 - − 0.75𝐴𝑐 -$# + 0.125𝐴𝑐 -$& = 0

𝑐 & − 0.75𝑐 + 0.125 = 0

⟹ 𝑐 = 0.5,0.25

𝛼- = 𝐴# (0.5)- + 𝐴& (0.25)-

Since, we know the initial conditions (𝛼" = 1, 𝛼# = 0.75)

𝐴# + 𝐴& = 𝛼" = 1

50𝐴# + 25𝐴& = 𝛼# = 75

Solving the above equations simultaneously, we get

𝐴# = 2, 𝐴& = −1

Therefore,

𝛼- = 2(0.5)- − (0.25)-
ii

𝑦! = 3 + 0.25𝑦!$# + 0.375𝑦!$& + 𝜖!

Let, 𝑦! = ( 𝑎- 𝜖!$-
-("

Equating the above equations, we get

𝛼" 𝜖! + 𝛼# 𝜖!$# . . . . . = 0.25[𝛼" 𝜖!$# + 𝛼# 𝜖!$& . . . ] + 0.375[𝛼" 𝜖!$& + 𝛼# 𝜖!$/ . . . ] + 𝜖!

(𝛼" − 1)𝜖! + (𝛼# − 0.25𝛼" )𝜖!$# + (𝛼& − 0.25𝛼# − 0.375𝛼" )𝜖!$& . . . ..

Each of these conditions but hold true, therefore

𝛼" − 1 = 0 ⟹ 𝛼" = 1

𝛼# − 0.25𝛼" = 0 ⟹ 𝛼# = 0.25

𝛼- = 0.25𝛼-$# + 0.375𝛼-$&

Solving the equation:

𝐿𝑒𝑡 𝛼- = 𝐴𝑐 -

Substituting,

𝐴𝑐 - − 0.25𝐴𝑐 -$# − 0.375𝐴𝑐 -$& = 0

𝑐 & − 0.25𝑐 − 0.375 = 0

⟹ 𝑐 = −0.5,0.75

𝛼- = 𝐴# (−0.5)- + 𝐴& (0.75)-

Since, we know the initial conditions (𝛼" = 1, 𝛼# = 0.25)

𝐴# + 𝐴& = 𝛼" = 1

−50𝐴# + 75𝐴& = 𝛼# = 25

Solving the above equations simultaneously, we get

 𝐴# = 0.4, 𝐴& = 0.6

Therefore,

𝛼- = 0.4(−0.5)- + 0.6(0.75)-

Answer B

𝑦! = 3 + 0.75𝑦!$# − 0.125𝑦!$& + 𝜖!

Homogenous Solution:

Let, 𝑦! = 𝐴𝛽 !

Substituting,

𝐴𝛽 ! − 0.75𝐴𝛽 !$# + 0.125𝐴𝛽 !$& = 0

𝛽 & − 0.75𝛽 + 0.125 = 0

𝛽 = 0.25,0.5

𝑦!) = 𝐴# (0.25)! + 𝐴& (0.5)!

Particular Solution:

Let, 𝑦! = 𝑐

𝑐 − 0.75𝑐 + 0.125𝑐 = 3

𝑐 = 8

ii

𝑦! = 3 + 0.25𝑦!$# + 0.375𝑦!$& + 𝜖!

Homogenous Solution:

Let, 𝑦! = 𝐴𝛽 !
Substituting,

𝐴𝛽 ! − 0.25𝐴𝛽 !$# + 0.375𝐴𝛽 !$& = 0

𝛽 & − 0.25𝛽 + 0.375 = 0

𝛽 = 0.75, −0.5

𝑦!) = 𝐴# (0.75)! + 𝐴& (−0.5)!

Particular Solution:

Let, 𝑦! = 𝑐

𝑐 − 0.250𝑐 − 0.375𝑐 = 3

𝑐 = 8

Answer C

General Solution:

𝑦! = 𝐴# (0.25)! + 𝐴& (0.5)! + 8 + ( 𝛼- 𝜖!$-

-("

Since ∀𝑡, 𝜖- = 0

𝑦! = 𝐴# (0.25)! + 𝐴& (0.5)! + 8

At 𝑡 = 0

𝑦" = 𝐴# + 𝐴& + 8

At 𝑡 = 2

𝑦# = 𝐴# (0.25) + 𝐴& (0.5) + 8

Since, 𝑦" = 𝑦#
Therefore

𝐴# + 𝐴& = 𝐴# (0.25) + 𝐴& (0.5)

⟹ 𝐴# = 𝐴& = 0

ii

General Solution:

0
! !
𝑦! = 𝐴# (0.75) + 𝐴& (−0.5) + 8 + ( 𝛼- 𝜖!$-
-("

Since ∀𝑡, 𝜖- = 0

𝑦! = 𝐴# (0.75)! + 𝐴& (−0.5)! + 8

At 𝑡 = 0

𝑦" = 𝐴# + 𝐴& + 8

At 𝑡 = 2

𝑦# = 𝐴# (0.75) − 𝐴& (0.5) + 8

Since, 𝑦" = 𝑦# = 8

Therefore

𝐴# + 𝐴& = 𝐴# (0.75) − 𝐴& (0.5)

⟹ 𝐴# = 𝐴& = 0