ECON334 Assignment 2

Q1.
a)

We observe a geometric decaying pattern in the ACF, with the ACF significant for
the first 24 lags, this suggests a possible AR process. We can also observe an
oscillating PACF which may suggest one of the coefficients of an AR variable is
negative. The correlogram suggests that the the unemployment rate follows an
AR(2) model and has a positive coefficient for the 1st lagged AR variable and there
exists a negative coefficient for the 2nd lagged AR variable.

b)

The ACF decays for the first few lags but then starts to fluctuate after the 5th lag
which like previously, suggests a possible AR process. This fluctuation can most
likely be contributed by a small AR/MA variable. We can see that the 1 st 2nd 3rd 8th
and 12th lags are significant but the last 3 mentioned are possibly due to a
variation in the sample so we must only look at the first 2. Since the first 2 ACF
and first PACF lags are significant we can believe we are following an ARMA(1,2)
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model. Similar to part a) we can observe that the PACF is oscillating and that at
least 1 coefficient of our AR/MA model is negative.
c) Model 1

y t =0.001+ 0.643 y t10.268 t4 0.324 t8 + t

( t . stat )( 0.042 ) ( 11.206 ) (3.740 )(4.618 )

( S . E . ) ( 0.020 ) ( 0.057 ) ( 0.072 )( 0.070 )
T = 184 R2 = 0.453
Model 2

y t =0.001+ 0.643 y t10.154 t 40.324 0+ t

( t . stat )(0.065 ) ( 10.926 )(2.703 ) (4.535 )

( S . E . ) ( 0.023 ) ( 0.057 ) ( 0.057 ) ( 0.071 )
T = 184 R2 = 0.435

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Model 3

y t =0.002+0.620 y t 10.128 y t4 0.141 y t8 + t

( t . stat )(0.064 ) ( 10.751 )(2.242 ) (2.572 )

( S . E . ) ( 0.027 ) ( 0.058 ) ( 0.057 ) ( 0.055 )
T = 184 R2 = 0.411
After we adjust the sample for the 3 models and have the same number of
observations we can compare the AIC for each one of them. Model 1 AIC: -.096
Model 2 AIC: -.063 Model 3 AIC: -.022. We would therefore choose Model 1 as it
has the lowest AIC.
d)

H0: 1= 2= 3= 4= 5=0
H1: At least one is not 0.
The Q* follows a chi-square distribution with 2 df. We reject null hypothesis as
Q*>5.992 at 5% sf. However since 3.518<5.992, dont have enough evidence to
reject the null hypothesis which means there is not enough evidence to suggest
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that the data is serially correlated.

2.
a)

^
Spot t =0.066+0.916 Forward t 4

( t . stat )( 4.955 ) (52.218)

( S . E . ) ( 0.013 ) (0.018)
T = 318 R2 = 0.897

b)

The ACF is initially decaying which suggests that the residuals followed an AR process.
However the ACF increases again after the 5th lag where it becomes significant once
more. The PACF is oscillating as we can see a pattern where there is a large increase in
the 1st lag and a large decrease in the 2nd after which we see a repeat.

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c)

^
Spot t =0.066+0.916 Forward t 4

( t . stat )( 2.794 ) (28.349)

( S . E . ) ( 0.023 ) (0.032)
T = 318 R2 = 0.897
H0: 1 = 1
H1: 1 1
T statistic = (0.916-1)/0.032 = -2.615
With 312 df at a 5% sf it is too large for the t value to be normally distributed. Since
2.615>1.96 at the 5% sf we can see that 1 1. Hence a forward market is not efficient
if 1 1 as it must be equal to 1 for it to be significant.

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3.
a) AR(2) Model

^
Spread t =1.387+1.109 ^
Spread t10.245 ^
Spread t 2

( t . stat )( 4.866 )( 15.650 ) (3.460 )

( S . E . ) ( 0.285 ) ( 0.071 )( 0.071 )

T = 191 R2 = 0.805
4
3
2
1
0
-1

-2

1
0
-1
-2
-3
-4
1965

1970

1975

1980

Residual

1985

1990

Actual

1995

2000

2005

Fitted

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The fitted equation matches our original spread almost exactly. This is reaffirmed with an
R-squared value of 0.803 and since it is close to 1 it shows how well the model actually
fits.

ARMA(2,1) Model

^
Spread t =1.395+ 0.440 ^
Spread t1 +0.352 ^
Spread t2 +0.729 ^
t 1

( t . stat )( 4.390 )( 2.951 ) ( 2.474 ) (6.367)

( S . E . ) ( 0.318 ) ( 0.149 ) ( 0.142 )(0.114)

T = 191 R2 = 0.813
4
3
2
1
0
2

-1

-2

0
-1
-2
-3
-4
1965

1970

1975

1980

Residual

1985

1990

Actual

1995

2000

2005

Fitted

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ECON334 Assignment 2
The above graph almost exactly matches the fitted and original spread. This is reaffirmed
with an R-squared value of 0.813 and since it is close to 1 it shows how well the model
actually fits.

b)
AR(2) Model

ARMA(2,1) Model

The model on the left has an RSME of 0.429 whilst the one on the right has an RSME of
0.441. Therefore we would select the AR(2) model as it has a smaller RSME.
c)
AR(2) Model

ARMA(2,1) Model

The model on the left has an RSME of 1.138 whilst the one on the right has an RSME of
1.156. Therefore we would choose the AR(2) Model as it has a smaller RSME.

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ECON334 Assignment 2

d)

As seen above the AR(2) has an RSME of 0.430 whilst the ARMA(2,1) has an RSME of
0.447. Therefore we would choose the AR(2) model since it has the lower RSME.

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