ACF plot PACF plot

𝝓>𝟎 𝝓<𝟎 𝝓>𝟎 𝝓<𝟎

Exponential decay 𝝆𝒌 = 𝝓𝒌 Oscillating decay 𝝆𝟏𝟏 = 𝝓𝟏 , 𝝆𝒌𝒌 = 𝟎 𝒇𝒐𝒓 𝒌 > 𝟏 𝝆𝟏𝟏 = 𝝓𝟏 , 𝝆𝒌𝒌 = 𝟎 𝒇𝒐𝒓 𝒌 > 𝟏

AR(1)

𝜽>𝟎 𝜽<𝟎 𝜽>𝟎 𝜽<𝟎

Positive at lag 1, 𝝆𝒌 = 𝟎 𝒇𝒐𝒓 𝒌 > 𝟏 Negative at lag 1, 𝝆𝒌 = 𝟎 𝒇𝒐𝒓 𝒌 > 𝟏 Oscillating decay Exponential decay

MA(1)
 𝝓>𝟎 𝝓<𝟎 𝝓>𝟎 𝝓<𝟎
Exponential decay from lag 1 Oscillating decay from lag 1 Oscillating decay from lag 1 Exponential decay from lag 1

ARMA(1,1)

Oscillating or Exponential decay Spikes at first p lags, zero after p lags

AR(p)
 Spikes at first p lags, zero after p lags Oscillating or Exponential decay

MA(q)

Exponential or Oscillator decay beginning at lag q Exponential or Oscillator decay beginning at lag q

ARMA(p,q
)

Notes: In both ACF and PACF plots, it’s not clear whether they are tailing off or cutting off. That’s where ARMA comes in. With ARMA, the orders of p and q for
AR and MA can be more than one. So testing out a few p and q combinations is advised to get the better score of AIC and BIC.
To get p value for AR for ARMA model, we will look at PACF plots. The spikes are at 1, 2 and 3. Thus it’s AR(1), AR(2) and AR(3). To get q value, we will look at
ACF plot. The spikes between 1 and 6. Thus it’s MA(1), MA(2), MA(3), MA(4), MA(5) and MA(6).
Therefore, p = 3 and q = 6. Lag equal to 6 is considered a big * lag, therefore I will test up to lag = 4, if none of the tentative models that I will access satisfy the
residual conditions, then I will estimate with a higher number of lags.
*
Please note, if the purpose of your analysis is to identify the model that best fits to the sample data, then you might choose q=6, but if the purpose of your
analysis is to forecast it is highly unlikely to choose q=6, because the forecasting accuracy is reducing as the number of parameters that we have to estimate is
increasing.
Therefore, based on the number of lags that we identified from the ACF and PACF plot we can try out several (i.e. 19) different combinations of ARMA(1,1),
ARMA(1,3), ARMA(4,1), ARMA(3,2), ARMA(3,4) and ARMA(4,4). Don’t worry about not getting the right orders for these ARMA models because we always do
diagnostics for all the models to see their performance. In addition, we also choose the best model by their AIC and BIC scores.