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ßasic

Ecoooæetrics, Fourth

Editioo

ModeIs

22. Iiæe 8eries

Ecoooæetrics. Forecastiog Cuauories, Z00+

856 PART FOUR: SÌMULTANEOUS-EQUATÌON MODELS

20

PIIIIµ Hans Iranses, Tinc Scrics Modc/s jor Eusincss and Icononic Iorccas/in¸, Can-

LrIdge UnIversIIy Press, Nev York, 1998, µ. 155.

21

R. LngIe, "AuIoregressIve CondIIIonaI HeIeroscedasIIcIIy vIII LsIInaIes oI IIe VarIance

oI UnIIed KIngdon InlaIIon,¨ Icononc/rica, voI. 50. no. 1, 1982, µµ. 987-1007. See aIso A. Bera

and M. HIggIns, "ARCH ModeIs: ProµerIIes, LsIInaIIon and TesIIng,¨ 1ourna/ oj Icononic Sur-

vcys, voI. 7, 1993, µµ. 305-366.

22.10 MEASURING VOLATILITY IN FINANCIAL TIME SERIES:

THE ARCH AND GARCH MODELS

As noIed In IIe InIroducIIon Io IIIs cIaµIer, hnancIaI IIne serIes, sucI as

sIock µrIces, excIange raIes, InlaIIon raIes, eIc. oIIen exIILII IIe µIenone-

non oI volutility clustering, IIaI Is, µerIods In vIIcI IIeIr µrIces sIov vIde

svIngs Ior an exIended IIne µerIod IoIIoved Ly µerIods In vIIcI IIere Is

reIaIIve caIn. As PIIIIµ Iranses noIes:

SInce sucI [hnancIaI IIne serIes| daIa relecI IIe resuII oI IradIng anong Luyers

and seIIers aI, Ior exanµIe, sIock narkeIs, varIous sources oI nevs and oIIer ex-

ogenous econonIc evenIs nay Iave an InµacI on IIe IIne serIes µaIIern oI asseI

µrIces. GIven IIaI nevs can Iead Io varIous InIerµreIaIIons, and aIso gIven IIaI

sµecIhc econonIc evenIs IIke an oII crIsIs can IasI Ior sone IIne, ve oIIen oLserve

IIaI Iarge µosIIIve and Iarge negaIIve oLservaIIons In hnancIaI IIne serIes Iend Io

aµµear In cIusIers.

20

KnovIedge oI voIaIIIIIy Is oI crucIaI InµorIance In nany areas. Ior ex-

anµIe, consIderaLIe nacroecononeIrIc vork Ias Leen done In sIudyIng IIe

varIaLIIIIy oI InlaIIon over IIne. Ior sone decIsIon nakers, InlaIIon In II-

seII nay noI Le Lad, LuI IIs varIaLIIIIy Is Lad Lecause II nakes hnancIaI

µIannIng dIIhcuII.

TIe sane Is Irue oI InµorIers, exµorIers, and Iraders In IoreIgn excIange

narkeIs, Ior varIaLIIIIy In IIe excIange raIes neans Iuge Iosses or µrohIs.

InvesIors In IIe sIock narkeI are oLvIousIy InIeresIed In IIe voIaIIIIIy oI

sIock µrIces, Ior IIgI voIaIIIIIy couId nean Iuge Iosses or gaIns and Ience

greaIer uncerIaInIy. In voIaIIIe narkeIs II Is dIIhcuII Ior conµanIes Io raIse

caµIIaI In IIe caµIIaI narkeIs.

Hov do ve nodeI hnancIaI IIne serIes IIaI nay exµerIence sucI voIaIII-

IIy? Ior exanµIe, Iov do ve nodeI IInes serIes oI sIock µrIces, excIange

raIes, InlaIIon, eIc.? A cIaracIerIsIIc oI nosI oI IIese hnancIaI IIne serIes Is

IIaI In IIeIr /cvc/ jorn IIey are randon vaIks, IIaI Is, IIey are nonsIaIIon-

ary. On IIe oIIer Iand, In IIe hrsI dIIIerence Iorn, IIey are generaIIy sIa-

IIonary, as ve sav In IIe case oI GDP serIes In IIe µrevIous cIaµIer even

IIougI GDP Is noI sIrIcIIy a hnancIaI IIne serIes.

TIereIore, InsIead oI nodeIIng IIe IeveIs oI hnancIaI IIne serIes, vIy noI

nodeI IIeIr hrsI dIIIerences? BuI IIese hrsI dIIIerences oIIen exIILII vIde

svIngs, or volutility, suggesIIng IIaI IIe varIance oI hnancIaI IIne serIes

varIes over IIne. Hov can ve nodeI sucI "varyIng varIance¨? TIIs Is vIere

IIe so-caIIed uutoregressive conditionul heteroscedusticity (ARCH)

nodeI orIgInaIIy deveIoµed Ly LngIe cones In Iandy.

21

As IIe nane suggesIs, IeIeroscedasIIcIIy, or unequaI varIance, nay Iave

an auIoregressIve sIrucIure In IIaI IeIeroscedasIIcIIy oLserved over dIIIer-

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Ecoooæetrics, Fourth

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ModeIs

22. Iiæe 8eries

Ecoooæetrics. Forecastiog Cuauories, Z00+

CHAPTER TWENTY-TWO: TÌME SERÌES ECONOMETRÌCS: FORECASTÌNG 857

enI µerIods nay Le auIocorreIaIed. To see vIaI aII IIIs neans, IeI us con-

sIder a concreIe exanµIe.

U.S./U.K. EXCHANGE RATE: AN EXAMPLE

Figure 22.6 gives logs of the monthly U.S./U.K. exchange rate (dollars per pound) for the

period 1973 to 1995, for a total of 276 monthly observations. As you can see from this fgure,

there are considerable ups and downs in the exchange rate over the sample period. To

see this more vividly, in Figure 22.7 we plot the changes in the logs of the exchange rate; note

that changes in the log of a variable denote relative changes, which, if multiplied by 100,

give percentage changes. As you can observe, the relative changes in the U.S./U.K. ex-

change rate show periods of wide swings for some time period and periods of rather moder-

ate swings in other time periods, thus exemplifying the phenomenon of volatility clustering.

Now the practical question is: How do we statistically measure volatility? Let us illustrate

this with our exchange rate example.

Let Y

t

U.S./U.K. exchange rate

Y

t

* log of Y

t

dY

t

* Y

t

* Y

t

*

1

relative change in the exchange rate

d

Y

t

* mean of dY

t

*

X

t

dY

t

* d

Y

t

*

Thus, X

t

is the mean-adjusted relative change in the exchange rate. Now we can use X

2

t

as

a measure of volatility. Being a squared quantity, its value will be high in periods when there

are big changes in the prices of fnancial assets and its value will be comparatively small

when there are modest changes in the prices of fnancial assets.

22

74

0.0

76 78 80 82 84 86 88 90 92 94

0.2

0.4

0.6

0.8

1.0

Year

FIGURE 22.6 Log of U.S./U.K. exchange rate, 1973-1995 (monthly)

22

You nIgII vonder vIy ve do noI use IIe varIance oI X

/

X

2

/

n as a neasure oI voIaIII-

IIy. TIIs Is Lecause ve vanI Io Iake InIo accounI cIangIng voIaIIIIIy oI asseI µrIces over IIne. II

ve use IIe varIance oI X

/

, II vIII onIy Le a sIngIe vaIue Ior a gIven daIa seI.

(Continued)

ßujarati. ßasic

Ecoooæetrics, Fourth

Editioo

ModeIs

22. Iiæe 8eries

Ecoooæetrics. Forecastiog Cuauories, Z00+

858 PART FOUR: SÌMULTANEOUS-EQUATÌON MODELS

Accepting X

2

t

as a measure of volatility, how do we know if it changes over time? Sup-

pose we consider the following AR(1), or ARÌMA (1, 0, 0), model:

X

2

t

0

1

X

2

t 1

u

t (22.10.1)

This model postulates that volatility in the current period is related to its value in the previous

period plus a white noise error term. Ìf

2

is positive, it suggests that if volatility was high in

the previous period, it will continue to be high in the current period, indicating volatility clus-

tering. Ìf

1

is zero, then there is no volatility clustering. The statistical signifcance of the es-

timated

2

can be judged by the usual t test.

There is nothing to prevent us from considering an AR(p) model of volatility such that

X

2

t

0

1

X

2

t 1

2

X

2

t 2

p

X

2

t p

u

t (22.10.2)

This model suggests that volatility in the current period is related to volatility in the past p pe-

riods, the value of p being an empirical question. This empirical question can be resolved by

one or more of the model selection criteria that we discussed in Chapter 13 (e.g., the Akaike

information measure). We can test the signifcance of any individual coeffcient by the t test

and the collective signifcance of two or more coeffcients by the usual F test.

Model (22.10.1) is an example of an ARCH(1) model and (22.10.2) is called an ARCH()

model, where p represents the number of autoregressive terms in the model.

Before proceeding further, let us illustrate the ARCH model with the U.S./U.K. exchange

rate data. The results of the ARCH(1) model were as follows.

X

2

t

0.0006 0.1694X

2

t 1

t (6.7831) (2.8355) R

2

0.0287 d 1.9972

(22.10.3)

where X

2

t

is as defned before.

U.S./U.K. EXCHANGE RATE: AN EXAMPLE (Continued)

(Continued)

74

-0.12

76 78 80 82 84 86 88 90 92 94

-0.08

-0.04

0.00

0.04

0.08

0.12

Year

FIGURE 22.7 Change in the log of U.S./U.K. exchange rate.

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Ecoooæetrics, Fourth

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Ecoooæetrics. Forecastiog Cuauories, Z00+

CHAPTER TWENTY-TWO: TÌME SERÌES ECONOMETRÌCS: FORECASTÌNG 859

Since the coeffcient of the lagged term is highly signifcant (p value of about 0.005), it

seems volatility clustering is present in the present instance. We tried higher-order ARCH

models, but only the AR(1) model turned out to be signifcant.

How would we test for the ARCH effect in a regression model in general that is based on

time series data? To be more specifc, let us consider the k-variable linear regression model:

Y

t

1

2

X

2t

k

X

kt

u

t

(22.10.4)

and assume that conditional on the information available at time (t 1), the disturbance term

is distributed as

u

t

N 0,

0

1

u

2

t 1

(22.10.5)

that is, u

t

is normally distributed with zero mean and

var (u

t

)

0

1

u

2

t 1

(22.10.6)

that is, the variance of u

t follows an ARCH(1) process.

The normality of u

t

is not new to us. What is new is that the variance of u at time t is de-

pendent on the squared disturbance at time (t 1), thus giving the appearance of serial cor-

relation.

23

Of course, the error variance may depend not only on one lagged term of the

squared error term but also on several lagged squared terms as follows:

var (u

t

)

2

t

0

1

u

2

t 1

2

u

2

t 2

p

u

2

t p

(22.10.7)

Ìf there is no autocorrelation in the error variance, we have

H

0

:

1

2

p

0 (22.10.8)

in which case var(u

t

)

0

, and we do not have the ARCH effect.

Since we do not directly observe

2

t

, Engle has shown that running the following regres-

sion can easily test the preceding null hypothesis:

u

2

t 0 1

u

2

t 1 2

u

2

t 2 p

u

2

t p

(22.10.9)

where u

t

, as usual, denote the OLS variance obtained from the original regression model

(22.10.4).

One can test the null hypothesis H

0

by the usual F test, or alternatively, by computing

nR

2

, where R

2

is the coeffcient of determination from the auxiliary regression (22.10.9). Ìt

can be shown that

nR

2

asy

2

p

(22.10.10)

that is, in large samples nR

2

follows the chi-square distribution with df equal to the number

of autoregressive terms in the auxiliary regression.

Before we proceed to illustrate, make sure that you do not confuse autocorrelation of the

error term as discussed in Chapter 12 and the ARCH model. Ìn the ARCH model it is the

(conditional) variance of u

t

that depends on the (squared) previous error terms, thus giving

the impression of autocorrelation.

U.S./U.K. EXCHANGE RATE: AN EXAMPLE (Continued)

23

A IecInIcaI noIe: RenenLer IIaI Ior our cIassIcaI IInear nodeI IIe varIance oI u

/

vas

assuned Io Le

2

, vIIcI In IIe µresenI conIexI Lecones uncondIIIonaI varIance. II

1

1, IIe

sIaLIIIIy condIIIon, ve can vrIIe

2

0

1

2

IIaI Is,

2

0

(1

1

) TIIs sIovs IIaI IIe

uncondIIIonaI varIance oI u does noI deµend on /, LuI does deµend on IIe ARCH µaraneIer

1

ßujarati. ßasic

Ecoooæetrics, Fourth

Editioo

ModeIs

22. Iiæe 8eries

Ecoooæetrics. Forecastiog Cuauories, Z00+

860 PART FOUR: SÌMULTANEOUS-EQUATÌON MODELS

NEW YORK STOCK EXCHANGE PRÌCE CHANGES

As a further illustration of the ARCH effect, Figure 22.8 presents monthly percentage change

in the NYSE (New York Stock Exchange) Ìndex for the period 1952-1995.

24

Ìt is evident from

this graph that the percent price changes in the NYSE Ìndex exhibit considerable volatility.

Notice especially the wide swing around the 1987 crash in stock prices.

To capture the volatility in the stock return seen in the fgure, let us consider a very simple

model:

Y

t

1

u

t (22.10.11)

where Y

t

percent change in the NYSE stock index and u

t

random error term.

Notice that besides the intercept, there is no other explanatory variable in the model.

From the data, we obtained the following OLS regression:

Y

t

0.00686

t (3.8835) (22.10.12)

d 1.9215

What does this intercept denote? Ìt is simply the average percent rate of return on the NYSE

index, or the mean value of Y

t

(can you verify this?). Thus over the sample period the aver-

age monthly return on the NYSE index was about 0.0069 percent.

24

TIIs graµI and IIe regressIon resuIIs µresenIed LeIov are Lased on IIe daIa coIIecIed Ly

Gary Kooµ, Ana/ysis oj Icononic Da/a, 1oIn WIIey & Sons, Nev York, 2000 (daIa Iron IIe daIa

dIsk). TIe nonIIIy µercenIage cIange In IIe sIock µrIce Index can Le regarded as a raIe oI re-

Iurn on IIe Index.

(Continued)

FIGURE 22.8

Monthly percent change in the NYSE Price Ìndex, 1952-1995.

55

-0.3

-0.2

-0.1

0.0

0.1

0.2

60 65 70 75 80 85 90 95

Year

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Ecoooæetrics, Fourth

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Ecoooæetrics. Forecastiog Cuauories, Z00+

CHAPTER TWENTY-TWO: TÌME SERÌES ECONOMETRÌCS: FORECASTÌNG 861

Now we obtain the residuals from the preceding regression and estimate the ARCH(1)

model, which gave the following results:

u

2

t

0.00145 0.1167u

2

t 1

t (8.8929) (2.6934) (22.10.13)

R

2

0.0136 d 2.0121

where u

t

is the estimated residual from regression (22.10.12).

Since the lagged squared disturbance term is statistically signifcant (p value of about

0.007), it seems the error variances are correlated; that is, there is an ARCH effect. We tried

higher-order ARCH models but only ARCH(1) was statistically signifcant.

What To Do if ARCH Is Present

RecaII IIaI ve Iave dIscussed severaI neIIods oI correcIIng Ior IeI-

eroscedasIIcIIy, vIIcI LasIcaIIy InvoIved aµµIyIng OLS Io IransIorned daIa.

RenenLer IIaI OLS aµµIIed Io IransIorned daIa Is generaIIzed IeasI

squares (GLS). II IIe ARCH eIIecI Is Iound, ve vIII Iave Io use GLS. We vIII

noI µursue IIe IecInIcaI deIaIIs, Ior IIey are Leyond IIe scoµe oI IIIs

Look.

25

IorIunaIeIy, soIIvare µackages sucI as LvIevs, SIazan, MIcrohI,

and Pc-GIve Iave nov user-IrIendIy rouIInes Io esIInaIe sucI nodeIs.

A Word on the Durbin-Watson and the ARCH Effect

We Iave renInded IIe reader severaI IInes IIaI a sIgnIhcanI d sIaIIsIIc nay

noI aIvays nean IIaI IIere Is sIgnIhcanI auIocorreIaIIon In IIe daIa aI

Iand. Very oIIen a sIgnIhcanI d vaIue Is an IndIcaIIon oI IIe nodeI sµecIh-

caIIon errors IIaI ve dIscussed In CIaµIer 13. Nov ve Iave an addIIIonaI

sµecIhcaIIon error, IIaI due Io IIe ARCH eIIecI. TIereIore, In a IIne serIes

regressIon, II a sIgnIhcanI d vaIue Is oLIaIned, ve sIouId IesI Ior IIe ARCH

eIIecI LeIore acceµIIng IIe d sIaIIsIIc aI IIs Iace vaIue. An exanµIe Is gIven In

exercIse 22.23.

A Note on the GARCH ModeI

SInce IIs "dIscovery¨ In 1982, ARCH nodeIIng Ias Lecone a grovII Indus-

Iry, vIII aII kInds oI varIaIIons on IIe orIgInaI nodeI. One IIaI Ias Lecone

NEW YORK STOCK EXCHANGE PRÌCE CHANGES (Continued)

25

ConsuII RusseII DavIdson and 1anes G. MacKInnon, Is/ina/ion and Injcrcncc in Icono-

nc/rics, OxIord UnIversIIy Press, Nev York, 1993, Sec. 16.4 and WIIIIan H. Greene, Icononc/-

ric Ana/ysis, 4II ed., PrenIIce HaII, LngIevood CIIIIs, N.1., 2000, Sec. 18.5.

ßujarati. ßasic

Ecoooæetrics, Fourth

Editioo

ModeIs

22. Iiæe 8eries

Ecoooæetrics. Forecastiog Cuauories, Z00+

862 PART FOUR: SÌMULTANEOUS-EQUATÌON MODELS

µoµuIar Is IIe generulized uutoregressive conditionul heteroscedusticity

(GARCH) nodeI, orIgInaIIy µroµosed Ly BoIIersIev.

26

TIe sInµIesI GARCH

nodeI Is IIe GARCH(1, 1) nodeI, vIIcI can Le vrIIIen as:

2

/

0

1

u

2

/1

2

2

/1

(22.10.14)

vIIcI says IIaI IIe condIIIonaI varIance oI u aI IIne / deµends noI onIy on

IIe squared error Iern In IIe µrevIous IIne µerIod [as In ARCH(1)| LuI aIso

on IIs condIIIonaI varIance In IIe µrevIous IIne µerIod. TIIs nodeI can Le

generaIIzed Io a GARCH( p, q) nodeI In vIIcI IIere are p Iagged Ierns oI

IIe squared error Iern and q Ierns oI IIe Iagged condIIIonaI varIances.

We vIII noI µursue IIe IecInIcaI deIaIIs oI IIese nodeIs, as IIey are In-

voIved, exceµI Io µoInI ouI IIaI a GARCH(1, 1) nodeI Is equIvaIenI Io an

ARCH(2) nodeI and a GARCH( p, q) nodeI Is equIvaIenI Io an ARCH(p q)

nodeI.

27

Ior our U.S./U.K. excIange raIe and NYSL sIock reIurn exanµIes, ve

Iave aIready sIaIed IIaI an ARCH(2) nodeI vas noI sIgnIhcanI, suggesIIng

IIaI µerIaµs a GARCH(1, 1) nodeI Is noI aµµroµrIaIe In IIese cases.

22.11 CONCLUDING EXAMPLES

We concIude IIIs cIaµIer Ly consIderIng a Iev addIIIonaI exanµIes IIaI II-

IusIraIe sone oI IIe µoInIs ve Iave nade In IIIs cIaµIer.

THE RELATÌONSHÌP BETWEEN THE HELP-WANTED ÌNDEX (HWÌ) AND

THE UNEMPLOYMENT RATE (UN) FROM JANUARY 1969 TO JANUARY 2000

To study causality between HWÌ and UN, two indicators of labor market conditions in the

United States, Marc A. Giammatteo considered the following regression model

28

:

HWÌ

t

0

25

i 1

i

UN

t i

25

j

j

HWÌ

t j

(22.11.1)

UN

t

0

25

i 1

i

UN

t i

25

j 1

j

HWÌ

t j

(22.11.2)

To save space we will not present the actual regression results, but the main conclusion that

emerges from this study is that there is bilateral causality between the two labor market indi-

cators and this conclusion did not change when the lag length was varied. The data on HWÌ

and UN are given in the data disk.

26

T. BoIIersIev, "GeneraIIzed AuIoregressIve CondIIIonaI HeIeroscedasIIcIIy,¨ 1ourna/ oj

Icononc/rics, voI. 31, 1986, µµ. 307-326.

27

Ior deIaIIs, see DavIdson and MacKInnon, oµ. cII., µµ. 558-560.

28

Marc A. GIannaIIeo (WesI PoInI, CIass oI 2000), "TIe ReIaIIonsIIµ LeIveen IIe HeIµ

WanIed Index and IIe UnenµIoynenI RaIe,¨ unµuLIIsIed Iern µaµer. (NoIaIIons aIIered Io

conIorn Io our noIaIIon.)

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Ecoooæetrics, Fourth

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CHAPTER TWENTY-TWO: TÌME SERÌES ECONOMETRÌCS: FORECASTÌNG 863

29

I an IIankIuI Io Gregory M. OgLorn and Marc C. OgLorn (WesI PoInI, CIass oI 2001) Ior

coIIecIIng and anaIyzIng IIe daIa.

ARÌMA MODELÌNG OF THE YEN/DOLLAR EXCHANGE RATE:

JANUARY 1971 TO DECEMBER 1998

29

The yen/dollar exchange rate (¥/$) is a key exchange rate. From the logarithms of the

monthly ¥/$, it was found that in the level form this exchange rate showed the typical pattern

of a nonstationary time series. But examining the frst differences, it was found that they were

stationary; the graph here pretty much resembles Figure 22.8.

Unit root analysis confrmed that the frst differences of the logs of ¥/$ were stationary.

After examining the correlogram of the log frst differences, we estimated the following

ARÌMA(1, 0, 2) model:

Y

t

0.0034 0.9678Y

t 1

0.5866u

t 1

0.4057u

t 2

t (4.3638) (67.5439) (11.4361) (7.9532) (22.11.3)

R

2

0.1454 d 1.9803

where Y

t

frst differences of the logs of ¥/$ and u is a white noise error term.

To save space, we have provided the data underlying the preceding analysis in the data

disk. Using these data, the reader is urged to try other models and compare their forecasting

performances.

ARCH MODEL OF THE U.S. ÌNFLATÌON RATE: JANUARY 1947 TO JANUARY 2001

To see if the ARCH effect is present in the U.S. infation rate as measured by the CPÌ, we

obtained CPÌ data from January 1947 to January 2001. The plot of the logarithms of the CPÌ

showed that the time series was nonstationary. But the plot of the frst differences of the logs

of the CPÌ, as shown in Figure 22.9, show considerable volatility even though the frst differ-

ences are stationary.

(Continued)

FIGURE 22.9 First differences of the logs of CPÌ.

50

-0.010

-0.005

0.000

0.005

0.010

0.015

0.020

55 60 65 70 75 80 85 90 95 00

Year

ßujarati. ßasic

Ecoooæetrics, Fourth

Editioo

ModeIs

22. Iiæe 8eries

Ecoooæetrics. Forecastiog Cuauories, Z00+

864 PART FOUR: SÌMULTANEOUS-EQUATÌON MODELS

Following the procedure outlined in regressions (22.10.12) and (22.10.13), we frst re-

gressed the logged frst differences of CPÌ on a constant and obtained residuals from this

equation. Squaring these residuals, we obtained the following ARCH(3) model:

u

2

t

0.000052 0.3399u

2

t 1

0.1338u

2

t 2

0.0920u

2

t 3

t (5.1893) (8.7270) (3.5620) (2.5387) (22.11.4)

R

2

0.2153 d 2.0334

As you can see, there is quite a bit of persistence in the volatility, as volatility in the current

month depends on volatility in the preceding 3 months. The reader is advised to obtain CPÌ

data from government sources and try to see if another model does a better job, preferably a

GARCH model.

22.12 SUMMARY AND CONCLUSIONS

1. Box-1enkIns and VAR aµµroacIes Io econonIc IorecasIIng are aIIer-

naIIves Io IradIIIonaI sIngIe- and sInuIIaneous-equaIIon nodeIs.

2. To IorecasI IIe vaIues oI a IIne serIes, IIe LasIc Box-1enkIns sIraIegy

Is as IoIIovs:

u. IIrsI exanIne IIe serIes Ior sIaIIonarIIy. TIIs sIeµ can Le done Ly

conµuIIng IIe auIocorreIaIIon IuncIIon (ACI) and IIe µarIIaI auIocorreIa-

IIon IuncIIon (PACI) or Ly a IornaI unII rooI anaIysIs. TIe correIograns

assocIaIed vIII ACI and PACI are oIIen good vIsuaI dIagnosIIc IooIs.

b. II IIe IIne serIes Is noI sIaIIonary, dIIIerence II one or nore IInes Io

acIIeve sIaIIonarIIy.

c. TIe ACI and PACI oI IIe sIaIIonary IIne serIes are IIen conµuIed Io

hnd ouI II IIe serIes Is µureIy auIoregressIve or µureIy oI IIe novIng average

Iyµe or a nIxIure oI IIe Ivo. Iron Lroad guIdeIInes gIven In TaLIe 22.1 one

can IIen deIernIne IIe vaIues oI p and q In IIe ARMA µrocess Io Le hIIed.

AI IIIs sIage IIe cIosen ARMA(p, q) nodeI Is IenIaIIve.

d. TIe IenIaIIve nodeI Is IIen esIInaIed.

e. TIe resIduaIs Iron IIIs IenIaIIve nodeI are exanIned Io hnd ouI II

IIey are vIIIe noIse. II IIey are, IIe IenIaIIve nodeI Is µroLaLIy a good

aµµroxInaIIon Io IIe underIyIng sIocIasIIc µrocess. II IIey are noI, IIe

µrocess Is sIarIed aII over agaIn. TIereIore, IIe Box-1enkIns neIIod Is

IIeraIIve.

l. TIe nodeI hnaIIy seIecIed can Le used Ior IorecasIIng.

3. TIe VAR aµµroacI Io IorecasIIng consIders severaI IIne serIes aI a

IIne. TIe dIsIInguIsIIng IeaIures oI VAR are as IoIIovs:

u. II Is a IruIy sInuIIaneous sysIen In IIaI aII varIaLIes are regarded as

endogenous.

ARCH MODEL OF THE U.S. ÌNFLATÌON RATE: . . . (Continued)

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