Mock Final Exam

Métodos Estadı́sticos para Finanzas (EST-36102)

Instructions
The exam contains 4 short questions, each for 10 points; and 2 long questions, each for 30 points.
You should upload your answers to Canvas before 23:55 on Friday 10th of December. You should
attempt ALL questions.

Short Questions
1. Parameter Stability (10 points)
Suppose that we estimate an OLS model to analyse the relationship between volatility of the
MXN, y in percent, and volatility of the price of oil, x in percent. We know that this relationship
changed in November 2014, when oil prices collapsed. We want to conduct a Chow test to assess
this change. We have monthly data from January 1995 to November 2021. The pvalue for the
Chow test of a break in November 2014 is 0.09. What should we conclude if we use a 10 %
level for the test? (Mark one)

(a) We should reject the Null Hypothesis of stability.

(b) We should reject the Null Hypothesis of no stability.
(c) The Chow test is not adequate to test for a break in a specific date.

2. Dynamic Models (10 points)

We have the following three models:

yt = β1 + β2 x2t + γ1 yt−1 + γ2 x2t−1 + ut (1)

∆yt = β1 + β2 ∆x2t + γ1 ∆yt−1 + γ2 ∆x2t−1 + ut (2)
∆yt = β1 + β2 ∆x2t + γ1 yt−1 + γ2 x2t−1 + ut (3)

Which of the following statements is TRUE concerning these ARDL models? (Mark one)
(a) (1) and (2) are equivalent (i.e. they are different ways of writing the same model).
(b) All models are equivalent (i.e. they are different ways of writing the same model).
(c) (1) and (3) are equivalent (i.e. they are different ways of writing the same model).
3. Time Series Models (10 points)
Assume we have the following AR(1) estimated model (with Standard Errors in brackets):

yt = 0.589 yt−1 + ût

(0.155)

Which of the following statements is TRUE? (Mark one)

(a) We should be careful interpreting the R2 and the t-statistic.

(b) We should be able to represent the process as an infinite Moving Average process.
(c) We should estimate a Moving Average model since the estimate is much lower than 1.
4. Nonstationary Time Series (10 points)

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 When estimating an AR(1) model (with Standard Errors in brackets), we find that
yt = 0.988 yt−1 + ut
(0.005)

Moreover, we find that the Augmented Dickey Fuller (ADF) test is suggesting that we can not
reject the Null hypothesis. How should we proceed? (Mark one)
(a) We conclude that the estimate is zero since we can not reject the null in the ADF test.
(b) We proceed with our work because the t-test is larger than the rule of thumb of 2.
(c) We take differences and apply the ADF again.
(d) We take differences and proceed with our work.

Long Questions
1. Dynamic Models (30 points)
An analyst is working to produce a model that serves to explain the long-run dynamics of the
exchange rate in Mexico. He knows that the Power Purchasing Parity is the theory that rules
the long-run behaviour of the MXN, he also knows that there are a number of shocks causing
deviations from said behaviour. He then estimates an Error Correction model:
k k k
 X X X
∆st = α0 + α1 st−1 + α2 (pt−1 − p∗t−1 ) + βj ∆p∗t−j +

δj ∆pt−j + γj ∆st−j + ut
j=0 j=0 j=1

where st is the log of the nominal exchange rate, p∗t is the price level in the US, and pt is the
price level in Mexico.
1.1 If α0 = 3, α1 = −1 and α2 = −0.5, what is the long-run solution of the model? (Mark one) [10
points]
(a) s = 3-0.5(p-p*).
(b) s = 3-0.5(p*-p).
(c) s = 3+0.5(p-p*).
(d) s = -3+0.5(p-p*).
1.2 Assume just for this question that α1 > 0. Choose the correct statement. (Mark one) [5 points]
(a) Deviations of s from the equilibrium tend to dissipate.
(b) The model for s is stable.
(c) Deviations of s from the equilibrium dissipate in more than one period.
(d) Deviations of s from equilibrium do not dissipate.
1.3 The analyst calculated the following values for the information criterion for lags k:

k AIC SBIC HQIC

0 -1.360 -1.148 -1.388
1 -1.337 -1.296 -1.448
2 -1.277 -1.289 -1.455
3 -1.358 -1.277 -1.451
4 -1.365 -1.259 -1.445

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 If he wants to keep the more parsimonious model (the model with the least number of param-
eters) what criterion and lags should he choose? (Mark one) [5 points]
(a) AIC. 1.
(b) SBIC. 1.
(c) HQIC. 2.
(d) AIC. 4.
1.4 The analyst will use the estimated model to produce forecasts for the depreciation of the nominal
exchange rate ∆st . He obtains forecasts for pt and p∗t from the International Monetary Fund
for the following 1,6,12,24 months. Assume that α0 = 3, α1 = −1 and α2 = −0.5. Moreover,
assume that δj = βj = γj = 0 for all j, and that

Forecast Horizon (months) Error Correction Term

1 st−1 + α2 (pt−1 − p∗t−1 ) < 0
6 st−1 + α2 (pt−1 − p∗t−1 ) < 0
12 st−1 + α2 (pt−1 − p∗t−1 ) > 0
24 st−1 + α2 (pt−1 − p∗t−1 ) < 0

What is the expected sign of ∆st in each horizon, assuming everything else constant.(Mark
one) [10 points]
(a) Expected signs are: (-),(-),(+),(+).
(b) Expected signs are: (+),(+),(-),(-).
2. Time Series (30 points)

A researcher is analysing the dynamics of the US Ten year yield, yt . He knows that this series
can be modelled as an Autoregressive process. He also knows that the series displays high levels
of autocorrelation. Based on the SB information criteria He estimates the model:

yt = ϕyt−1 + ut

When the period used for estimation is from 1980m1 to 2007m7, he obtains (Standard Errors
in brackets):
yt = 0.864 yt−1 + ût
(0.418)

When the period used for estimation is from 1980m1 to 2021m11, he obtains (Standard Errors
in brackets):
yt = 0.975 yt−1 + ût
(0.185)

2.1 Given this information, what seems to be the main challenge the researcher is facing when using
the sample up-to 2021m11? (Mark all that apply) [5 points]
(a) There is a unit-root issue.
(b) t-statistic is not meaningful.
(c) y seems to be non-stationary.
2.2 The model will be used for forecasting. What is the researcher loosing if he uses the estimation
up-to 2007m7? (Mark all that apply) [5 points]

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 (a) Parameter estimates seems to be unstable, hence forecast are unreliable.
(b) Forecasts will not account for crises (Global Financial Crisis, COVID).
(c) Forecasts standard errors (uncertainty) will be too small.

2.3 The researcher is more interested in forecasting correctly the direction of change in yt than the
point forecast. He estimates the model in differences using the sample up-to 2021m11. He did
not test for a unit root in yt . What is the main problem that his forecasts may have? (Mark
one) [10 points]

(a) If there is a unit root, his forecasts of changes in y will not be valid.
(b) If there is not a unit root, he is inducing a moving average when there is none.
(c) If there is not a unit root, he should not take differences.
2.4 The researcher wants to test if there is a long-run relationship between the Ten year yield, yt
and the monetary policy interest rate, xt (i.e. he wants to test for cointegration between these
variables). The Augmented Dickey Fuller test statistic is -4.15, the critical value for a size of
10 % is -2.57. What can the researcher conclude about cointegration? (Mark one) [10 points]
(a) Residuals are cointegrated.
(b) Needs to test for a unit root in x.
(c) y and x are cointegrated.