Department of Economics Columbia University Problem Set 9 Introduction to Econometrics Profs. Seyhan E Arkonac and Christopher T.

Conlon for all sections.

W3412 Spring 2012

1. Data set cpi_unemp_1948_2011.dta is downloaded from St Louis Fed website and it is monthly starting from January 1948 and ending February 2011. a) Create a time variable that has monthly format and let STATA know that time is the variable you want to indicate t. Write your do file for creating time variable. b) Generate inflation (inf ) as the log difference in consumer price index and generate lagged inflation (dinf). Write your commands. c) For the dates beginning Jan 1974 and ending Jan 2011, run an AR(1), AR(3) and an AR(12) forecast models for the change in inflation rate. Compare these models by reporting adjusted R sq and necessary F tests. Now use each to forecast Feb 2011 inflation rate. Report the forecast error for each of the three models. Among these three which model would you prefer using, explain? d) Using unrate run three forecast models for change in inflation as an ADL(1,1), ADL(3,3) and ADL(3,1) models (use the same time period as in part c). Compare the performance of these three models. Now forecast Feb 2011 inflation rate and report forecast errors for each model. Among these three which model would you prefer using, explain? e) Compare the model you have selected in part (a) and the model in part (b). Among these two models which one performs more accurate forecast? f) Calculate 95% forecast intervals for the two models in part (e) 2. This question requires the material in Ch 16. Using cpi_unemp_1948_2011.dta as above, using the time period Jan 1997 to Dec 2010 estimate a VAR(3) model for change in unemployment rate and change in inflation rate. a) Does change in unemployment rate Granger-cause change in inflation rate? Does change in inflation rate Granger-cause change in unemployment rate? b) Construct iterated two-month-ahead pseudo out-of-sample forecasts using a VAR(3) model for dinf and dunrate for Feb 2011. c) Construct direct forecast for Feb 2011. Compare these forecasts to the ones in part (b). Which forecast is more accurate the iterated one? Or the direct one? 3. The clustering of high-profile terrorist events (e.g., the hijacking of TWA flight 847 on June 14, 1985; the hijacking of the Achille Lauro cruise ship on October 7, 1985; and the Abu Nidal attacks on the Vienne and Rome airports on December 27, 1985) caused much speculation in the press about tourists changing their travel plans. Similarly, the tourism industry is especially hard-hit after the attacks on September 11, 2001. Although the opinion polls of prospective tourists suggest that terrorism affect tourism, the true impact, if any, can best be analyzed through a distributed lag model. 1

Data set ITALY.dta contains data on de-seasonalized values of the logarithmic share of Italys tourism revenues in quarter t (itshare) and the number of transnational terrorist incidents within that country during quarter t (attkit). To investigate the effect of a transnational terrorist incident on Italys tourism revenue, run a distributed lag model with: a) The effect of an attack on current quarters tourism revenue, interpret the coefficient, make sure you are obtaining the correct standard errors. Is the effect significant at 5% level? b) The effect of an attack on current and next quarters tourism revenue, making sure the standard errors are correct. What is the impact multiplier? Explain the meaning. What is the cumulative multiplier? Explain the meaning. c) Cumulative effect of an attack in one year period on Italys tourism revenue. What is the meaning of the cumulative multiplier in this case? d) Discuss whether attkit exogenous or strictly exogenous or neither? e) Suppose transnational terrorist incidents increased by 10 for one quarter and stayed at that level for one whole year (so that attkit=10 and attkitt+1= attkitt+2 = attkitt+3= attkitt+4 = 0) What is the predicted effect on Italys tourism revenue over the next year? f) Construct a 90% confidence interval for your answer in part (e) g) Using the HAC F-statistic test whether the coefficients of attkitt and its lags are zero? Are the coefficients jointly significant?

The following questions will not be graded, they are for you to practice and will be discussed at recitation:

1. Purchasing power parity (PPP) is a simple relationship linking national price levels and exchange rates. In its simplest form, PPP asserts that the rate of currency depreciation is approximately equal to the difference between domestic and foreign inflation rates. If pt and pft denote the logarithm of U.S. and foreign price levels and et denotes the logarithm of the dollar price of foreign exchange, PPP implies et pt pft + dt where dt represents the deviation from PPP in period t. One popular testing procedure is to define the real exchange rate in period t: rt et + pt pft. Long-run PPP is said to hold if the {rt} sequence is stationary. a) Using data set panel.dta, visually inspect real exchange rates of three major U.S. trading partners: Germany, Canada and Japan. This data set contains quarterly values of the real effective exchange rates (cpi-based) for Australia, Canada, France, Germany, Japan, Netherlands, the United Kingdom and the United States over the 1980Q1-2008Q1 period. These are multilateral (not bilateral) real exchange rates. Report your graphs and decision about whether PPP holds in each of these three cases? (hint: as in any time series data you first need to generate the time variable that must start on 1980q1, then format, sort and tsset time. For graph you can use twoway line command) b) Report the first 8 autocorrelations for the real exchange rate in the same three countries and comment on your results (hint: use corrgram command, check slides for exact syntax of this command)

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

SW Exercise 14.1 SW Exercise 14.2 parts a, b and c only SW Exercise 14.4 SW Exercise 14.5 SW Empirical exercise 14.1 SW Empirical exercise 14.2 parts a and b only SW Empirical exercise 14.5 parts a and b only SW Exercise 15.1 SW Exercise 15.2 SW Empirical exercise 15.1 SW Empirical exercise 15.2 SW Empirical exercise 16.2