Professional Documents
Culture Documents
———————————————————–
1. Consider an AR(1) process: t = ρt−1 + ut , where E(ut ) = 0, E(u2t ) = σu2 , and E(ut us ) = 0 for
all t 6= s. Assume that t is stationary. Derive a formula for Cov(t , t−s ), the covariance of t
and t−s , that holds for s = 0, 1, 2, 3, . . ..
For each of the following time series processes, determine the variance of yt as a function of σu2
and of parameters appearing in the equations below. Also derive the first- and second-order
autocovariances and autocorrelations. Assume that the time series processes are stationary.
yt = µ + ρ1 yt−1 + ρ2 yt−2 + ut
where ρ2 6= 0. Are there values of ρ1 and ρ2 for which this process could be re-written in moving
average form as an MA(2) process? If so, what are the values of ρ1 and ρ2 ? If no such values
exist, briefly explain why not.
Consider the effect on y of a one-unit increase in x at time t∗ in the following two cases:
1
(a) x remains one unit higher permanently after time t∗ .
(b) x immediately returns to its former level at time t∗ + 1.
Obtain the estimated effect on y in each of these cases at the four time periods: t∗ , t∗ + 1, t∗ + 2,
and the long run effect, t∗ + ∞.
5. Consider a regression model with a constant term and three explanatory variables, which include
the lagged dependent variable yt−1 and two other variables, x1t and x2t . The estimated model is
(a) Obtain the estimated effect on y of a permanent one-unit increase in x1 at time t∗ (that is,
x1 remains one unit higher permanently after time t∗ ) at the four time periods: t∗ ; t∗ + 1;
t∗ + 2; and the long run effect, t∗ + ∞.
(b) Compare the size of the estimated effect on y of a permanent one-unit increase in x1 to
the size of the estimated effect on y of a permanent one-unit increase in x2 . Mention their
initial (time t∗ ) effects and their long run effects. No algebra or calculations are required.
(a) yt = µ + βyt−1 + ut
(b) yt = µ + ut + 0.6ut−1 + 0.2ut−2
derive
Assume: E(ut ) = 0 for all t; E(u2t ) = σ 2 for all t; E(ut ut−s ) = 0 for all t and s where s 6= 0; and
that the time series processes are stationary.
Consider the effect on y of a one-unit increase in x at time t∗ where x remains one unit higher
permanently after time t∗ . Obtain the estimated effect on y at time t∗ , t∗ + 1, t∗ + 2, and the
long run effect.
2
8. Consider a regression model with a constant term and three explanatory variables, which include
the lagged dependent variable yt−1 and two other variables, x1t and x2t . The estimated model is
(a) Obtain the estimated effect on y of a permanent one-unit increase in x1 at time t∗ (that is,
x1 remains one unit higher permanently after time t∗ ) at the four time periods: t∗ ; t∗ + 1;
t∗ + 2; and the long run effect, t∗ + ∞.
(b) Compare the size of the estimated effect on y of a permanent one-unit increase in x1 with
the size of the estimated effect on y of a permanent one-unit increase in x2 . Mention their
initial (time t∗ ) effects and their long run effects. No algebra or calculations are required.
t = ρt−1 + ut , t = 1, . . . , n
(a) What is the numerical value of the correlation between t and t−3
(b) What is the numerical value of Var(t )
(c) Suppose that E(ut ) = 10, instead of the usual zero-mean assumption. What is the numerical
value of E(t )?
(a) Var(yt )
(b) The correlation between yt and yt−1
(c) The covariance between yt and yt−1
Answers
1. (1 − ρL)t = ut ⇒ t = (1 − ρL)−1 ut
t = ut + ρut−1 + ρ2 ut−2 + . . .
3
Since E(t ) = 0 for all t, then
Because (Eut us ) = 0 for all t 6= s, the only terms with non-zero expectations in this product are
those with equal subscripts on the u’s. Then the above expression simplifies to
Cov(yt , yt−1 )
Corr(yt , yt−1 ) = p =β
Var(yt )Var(yt−1 )
and similarly
Corr(yt , yt−2 ) = β 2
4
(b) (yt − β) = t = ρt−1 + ut
= ρ(yt−1 − β) + ut
This is like (a) except now E(yt ) = β instead of = 0 and we now have ρ replacing part (a)’s
β. Then
Cov(yt , yt−2 ) = 0 (yt and yt−2 have no ut ’s in common and the ut ’s are not correlated)
θσu2 θ
Corr(yt , yt−1 ) = 2 2
=
(1 + θ )σu 1 + θ2
Corr(yt , yt−2 ) = 0
Cov(yt , yt−1 ) = E(ut + 0.6ut−1 + 0.2ut−2 + 0.1ut−3 )(ut−1 + 0.6ut−2 + 0.2ut−3 + 0.1ut−4 )
= 0.6σu2 + 0.12σu2 + 0.02σu2
= 0.74σu2
Cov(yt , yt−2 ) = E(ut + 0.6ut−1 + 0.2ut−2 + 0.1ut−3 )(ut−2 + 0.6ut−3 + 0.2ut−4 + 0.1ut−5 )
= 0.2σu2 + 0.06σu2
= 0.26σu2
0.74
Corr(yt , yt−1 ) = = 0.52
1.41
0.26
Corr(yt , yt−2 ) = = 0.18
1.41
5
3. Write this process as
(1 − ρ1 L − ρ2 L2 )yt = µ + ut
4. (Note that ∆ represents the change in y due to a change in x. It does not represent the first-
difference operator here.)
The permanent effect can be obtained from ∆y = 0.61∆y + 0.19∆y + 1.40∆x + 0.58∆x,
where ∆x is the permanent change in x. Then solve for ∆y:
6
(b) ∆yt∗ = 1.40∆xt∗ = 1.40
7. at t∗ ∆y = 9 × 1 = 9
at t∗ + 1, ∆y = 0.7 × 9 + 9 × 1 + 2 × 1 = 17.3
at t∗ + 2, ∆y = 0.7 × 17.3 − 0.4 × 9 + 9 × 1 + 2 × 1 = 19.51
9+2 11
long run effect is ∆y = 1−.7+.4 = 0.7 = 15.71
7
8. (a) Effect at time t∗ : −2.0
at time t ∗ +1 : −2.0 + 0.8 × (−2.0) = −3.6
at time t ∗ +2 : −2.0 + 0.8 × (−3.6) = −4.88
at time t ∗ +∞ : −2.0/(1 − .8) = −10.0
(b) At every time period, the effect of a change in x2 on y is −0.25 times the effect of a change
in x1 on y. This is because the coefficient on x2 is −0.25 times the coefficient on x1 . This
ratio does not change over time, because the way that the effect changes over time in this
model depends only on the coefficient on yt−1 , in the same way for both the x1 and x2
effects.
9. (a) When t follows a stationary AR(1) process with first-order autocorrelation coefficient ρ,
then Corr(t , t−s ) = ρs . Therefore Corr(t , t−3 ) = ρ3 = (0.6)3 = 0.216
(b) Var(t ) = ρ2 Var(t−1 ) + Var(ut )
Var(t ) = 0.36Var(t ) + 5
5
Var(t ) = 1−0.36 = 7.81
(c) E(t ) = ρE(t−1 ) + E(ut )
E(t ) = 0.6E(t ) + 10
10
E(t ) = 1−0.6 = 25
10. (a)
Var(yt ) = Var(ut ) + (.7)2 Var(ut−1 ) + (.1)2 Var(ut−2 )
= 20 + .49(20) + (.01)20
= 20(1 + .5) = 30
(c)
Cov(yt , yt−1 )
Corr(yt , yt−1 ) = p
Var(yt )Var(yt−1 )
15.4
= √ = .513
30 × 30