Faculty of Business and Law

School of Business

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ECON339
Applied Financial Modeling
Wollongong

Deferred and Supplementary Examination Paper

Spring, 2022

Exam duration 3 hours

Weighting 50 %

Items permitted by examiner NA

Aids supplied NA

Directions to students Answer ALL questions. Q1 (30 marks), Q2 (10 marks)

This exam paper must not be removed from the exam venue

2022 ECON339 Wollongong Spring 2022 Page 1 of 8

Q1. Gold has often been debated as a long-term hedge against inflation. In this question, we will test
whether the U.S. data support this proposition. Panel 1A shows the plot of the gold price (GPRICE) per troy
ounce in US$, while Panel 1B shows the annualised US inflation rate (INF) from December 1969 to August
2021.

Panel 1A: Gold price US$ Panel 1B: US inflation rate (%)

(a) Briefly explain the movement of the “GPRICE” and “INF”. [2]

(b) Panels 1C and 1D show the Augmented Dickey-Fuller (ADF) test results for the log(GPRICE) (i.e.,
LGPRICE) and INF, respectively. Why is the ADF test preferred to the DF test? [2]

(c) Write down the unit root test regression specification. [2]

Panel 1C (LGPRICE) Panel 1D (INF)

Exogenous: Constant, Linear Trend Exogenous: Constant, Linear Trend

Lag Length: 0 (Automatic - based on SIC, maxlag=18) Lag Length: 0 (Automatic - based on SIC, maxlag=18)

t-Statistic   Prob.* t-Statistic   Prob.*

Augmented Dickey-Fuller test Augmented Dickey-Fuller test

statistic -2.446591  0.3550 statistic -13.41585  0.0000
Test critical Test critical
values: 1% level -3.972925 values: 1% level -3.972949
5% level -3.417083 5% level -3.417095
10% 10%
level -3.130918 level -3.130925

2022 ECON339 Wollongong Spring 2022 Page 2 of 8

(d) Interpret the unit root test results in Panels 1C and 1D. What can you infer about the stationarity property
of LGPRICE and INF? [2]

(e) The regression output of LGPRICE on INF is shown below. Can you infer from this regression result?
Explain. [2]

Dependent Variable: LGPRICE

Method: Least Squares
Date: 09/27/21 Time: 12:10
Sample (adjusted): 1970M01 2021M08
Included observations: 620 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.  

INF 0.034774 0.005112 6.802009 0.0000

C 4.433328 0.050391 87.97825 0.0000
@TREND 0.004722 0.000112 42.04205 0.0000

R-squared 0.760146     Mean dependent var 6.032612

Adjusted R-squared 0.759369     S.D. dependent var 0.909837
S.E. of regression 0.446313     Akaike info criterion 1.229234
Sum squared resid 122.9034     Schwarz criterion 1.250668
Log likelihood -378.0625     Hannan-Quinn criter. 1.237565
F-statistic 977.7008     Durbin-Watson stat 0.077781
Prob(F-statistic) 0.000000

(f) I performed the Engle-Granger test on the U.S. logarithm of the consumer price index (LCPI) and
LGPRICE assuming that LCPI is I(1). At the 5% significance level, what can you infer about the test result?
[2]

Series: LCPI LGPRICE 

Sample: 1969M12 2021M08
Included observations: 621
Cointegrating equation deterministics: C 
Automatic lags specification based on Schwarz criterion (maxlag=18)

Dependent tau-statistic Prob.* z-statistic Prob.*

LCPI -1.367631  0.8103 -3.734399  0.8287
LGPRICE -1.777624  0.6415 -5.545364  0.6877

2022 ECON339 Wollongong Spring 2022 Page 3 of 8

(g) Given your findings in part (f), is gold a long-term hedge of inflation? Explain. [2]

(h) I proceed to study the short-run dynamic of the changes in gold price ( ∆ LGPRICE ¿ and inflation (INF)
and estimated a VAR model. Write down the VAR(1) model using the notation ∆ LGPRICE and INF. [2]

(i) The table below shows the different criteria used to determine the appropriate lag length of the VAR
model. What is the optimal lag length? [2]

VAR Lag Order Selection Criteria

Endogenous variables: DGPRICE INF 
Exogenous variables: C 
Date: 09/27/21 Time: 12:26
Sample: 1969M12 2021M08
Included observations: 612

 Lag LogL LR FPE AIC SC HQ

0 -810.0112 NA   0.048698  2.653631  2.668065  2.659245

1 -645.0795  328.2464  0.028781  2.127711   2.171012*   2.144552*
2 -642.2466  5.619539  0.028891  2.131525  2.203694  2.159594
3 -635.6927  12.95782  0.028651  2.123179  2.224215  2.162475
4 -626.5261  18.06369  0.028171  2.106294  2.236198  2.156818
5 -622.8897  7.141925  0.028205  2.107483  2.266254  2.169234
6 -618.2868  9.010285  0.028149  2.105512  2.293151  2.178492
7 -612.9209   10.46888*   0.028024*   2.101049*  2.317555  2.185255
8 -609.7500  6.165488  0.028101  2.103758  2.349132  2.199193

(j) Using the regression model in part (h), I performed the Granger causality test to determine the predictive
power of INF on ∆ LGPRICE , and vice versa. State the null hypothesis of these Granger causality tests
using the coefficients/parameters in the VAR specification. [2]

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(k) The result of the Granger causality test is based on a VAR(1) model.
What can you infer from this test result at the 5% significance level? [2]

VAR Granger Causality/Block Exogeneity Wald Tests

Date: 09/27/21 Time: 12:31
Sample: 1969M12 2021M08
Included observations: 619

Dependent variable: DGPRICE

Excluded Chi-sq df Prob.

INF  0.577845 1  0.4472

All  0.577845 1  0.4472

Dependent variable: INF

Excluded Chi-sq df Prob.

DGPRICE  5.477190 1  0.0193

All  5.477190 1  0.0193

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(l) I generated the impulse response diagrams from the VAR model with
the Cholesky ordering ∆ LGPRICE and INF.

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What can you infer about the persistence of the shock INF on itself compared to the shock of ∆ LGPRICE
on itself? [2]

(m) Looking at the impulse response diagrams, what can you infer about the short-run dynamic response of
inflation to ∆ LGPRICE shock? [2]

(n) I produced the impulse response function with the Cholesky ordering INF and ∆ LGPRICE . Why do I
need to produce this additional impulse response function based on a different Cholesky ordering? [2]

(o) The forecast error variance decomposition of the VAR is shown below. What can you infer from this
result? [2]

2022 ECON339 Wollongong Spring 2022 Page 7 of 8

Q2. Consider the following simultaneous equation models.

Y 1t=α 1 + β 3 Y 3t + δ 1 X 1t +u 1t (1)
Y 2t=α 2 + β 1 Y 1t + β 3 Y 3 t +u 2t (2)
Y 3t =α 3+ β 2 Y 2t +δ 2 X 2t +u 3 t (3)

(a) Can you estimate equation (1) with OLS assuming X 1 and X 2are exogenous? Explain [2]

(b) Use the order condition to identify which of the above equations are just identified. [2]

(c) Consider the following set of simultaneous equations:

Y 1t=α 1 +δ 1 X 1t + u1t (4 )
Y 2t=α 2 + β 1 Y 1t + β 3 Y 3 t +u 2t (5)
Y 3t =α 3+ β 2 Y 2t +δ 2 X 2t +u 3 t (6)

Can you estimate equation (4) with OLS assuming X 1 and X 2are exogenous? Explain. [2]

(d) Write down the reduced form equation for the endogenous variables Y 2t and Y 3t ? [2]

(e) Can you estimate equations (5) and (6) with the Indirect Least Square method? Explain. [2]

2022 ECON339 Wollongong Spring 2022 Page 8 of 8