MASTER IN TOURISM AND ENVIRONMENTAL ECONOMICS (MTEE)

Econometrics

Final Exam Time Series Analysis Part

MODELLING GREEK INDUSTRIAL PRODUCTION INDEX

By Italo Arbul Villanueva

January 2010
1 ECONOMETRICS Time Series Analysis Final Exam Arbul Italo Raul A. Arbul Villanueva

INDEX

1. INTRODUCTION ............................................................................... 3 2. THE BOX-JENKINS METHODOLOGY ........................................ 4 2.1. Identification ..................................................................................... 5 2.2. Estimation........................................................................................ 13 2.3. Checking .......................................................................................... 16 2.4. Forecast............................................................................................ 18 3. MAIN CONLUSIONS ....................................................................... 19

2 ECONOMETRICS Time Series Analysis Final Exam Arbul Italo Raul A. Arbul Villanueva

1. INTRODUCTION

In this work are detailed the steps of the modeling analysis of the Industrial Greek Production Index series by the Box-Jenkins methodology. Once the series is modeled, the pattern is used to make projections for the following three years.

The Box-Jenkins methodology allows to make efficient forecasting, starting exclusively from the information contained in a temporary series, but also this modeling univariante, is an indispensable tool to be able to build better and more complex models (that include other variables) in the future.

The analysis has been made with 240 observations that correspond to those the values of the monthly index of January from 1970 to December of 1989.

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2. THE BOX-JENKINS METHODOLOGY The time series econometric models in general require of four stages for their construction: Specification (in the language of Box-Jenkins, Identification), Estimation, Checking and Forecast. 1. Identification: Choose the orders p, d, q, P, D and Q and of the ARIMA(p; d; q) x SARIMA(P; D; Q) model. a. Choose depicting the time series. b. With the sample correlograms choose d and D. c. With the sample correlograms of the transformed data choose p, q, P and Q. d. Check in the AR processes are stationary and if the MA ones are invertible; otherwise modify the values of d and D. 2. Estimation: Once the ARIMA(p; d; q) x SARIMA(P; D; Q) is specified we have to check it. a. Check in the AR processes are stationary and if the MA ones are invertible; otherwise modify the values of d and D. b. Check if it possible to reject the null hypothesis in the individual significance tests associated fitted parameters. 3. Checking: Check if the residuals of the fitted model behave like a white noise process. a. Visual inspection of the residuals correlograms. b. Use of the Q Box-Pierce and Lunj-Box statistics. c. Selection between alternative models using information criteria. 4. Forecast

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Although the stages are successive (they should be carried out first the identification of the pattern and then its estimation), according to the result of each stage it can have retro-feeding. After a first estimation it can be concluded about the necessity of change the specification pattern.

2.1.

Identification

The first stage of the identification of an ARIMA x SARIMA model is the graphical analysis of the series.

100 90 80 70 60 50 40 30 70 72 74 76 78 80 GRE 82 84 86 88

As the series has an exponential behavior a transformation of the series is required in order to give place to a stationary series. In this sense, the construction of a new series wt is generally expressed as:

The function f(Yt) is in general a Box-Cox transformation which follows the expression:
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In this sense, the logarithmic transformation was established and the following graph shows this estimation:

4.6 4.4 4.2 4.0 3.8 3.6 3.4 70 72 74 76 78 80 82 84 86 88

_LOG_GRE

As we can appreciate in the graph is that the new time series is not stationary because the mean and the variance are no constant over the whole period analyzed. In this sense we need to take a difference of the time series. In order to know how many differences should be applied to the time series (d) we first check the correlogram.

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As we know in a stationary series it the correlogram tends exponentially to zero, but as we can observe from this correlogram that this is not the case. This correlogram give us the idea of the existence of a non stationary Autoregressive Process (AR) of order 1 because the Autocorrelation Function (AF) is not exponentially decaying to zero and the
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first coefficient of the Partial Autocorrelation Function (PAF) is statistically different from zero1. In order to confirm this, we made the regression of the time series using as an explanatory variable an AR(1).

Dependent Variable: _LOG_GRE Method: Least Squares Date: 12/30/09 Time: 10:57 Sample (adjusted): 1970M02 1989M12 Included observations: 239 after adjustments Convergence achieved after 2 iterations Variable AR(1) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Inverted AR Roots Coefficient 1.000731 0.918542 0.918542 0.064347 0.985440 317.0638 Std. Error 0.000989 t-Statistic 1012.052 Prob. 0.0000 4.206885 0.225455 -2.644885 -2.630339 2.648085

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Durbin-Watson stat

1.00 Estimated AR process is nonstationary

Now that it is confirmed the presence of a nonstationary process of order one, in order to get a stationary series we apply the first difference of the series (d=1). The following graph shows the new series (_D_log_GRE)

We can affirm that because the null hypothesis of no autocorrelation is rejected because the pvalue of the Q-stat is lower than the confidence level established (5%). 8 ECONOMETRICS Time Series Analysis Final Exam Arbul Italo Raul A. Arbul Villanueva

.3

.2

.1

.0

-.1

-.2 70 72 74 76 78 80 82 84 86 88

_D_LOG_GRE

The correlogram of the new series is shown in the following graph.

As we can

appreciate, the PAF and the AF show the possible presence of a season autoregressive process in the twelve period (SAR-12) since the PAF shows a big value on this period and the AF shows coefficients not decaying exponentially towards zero, this means, the presence of peaks over twelve periods (12, 24, 36).

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In order to confirm the presence of a seasonal process we also estimated a regression of the series over a SAR(12) process.

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Dependent Variable: _D_LOG_GRE Method: Least Squares Date: 12/30/09 Time: 10:57 Sample (adjusted): 1971M02 1989M12 Included observations: 227 after adjustments Convergence achieved after 2 iterations Variable AR(12) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Inverted AR Roots Coefficient 0.770461 0.583739 0.583739 0.042212 0.402695 396.8696 .98 .49+.85i -.49+.85i Std. Error 0.043171 t-Statistic 17.84656 Prob. 0.0000 0.003512 0.065426 -3.487838 -3.472750 2.677038 .49-.85i -.49-.85i -.98

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Durbin-Watson stat .85+.49i .00+.98i -.85-.49i .85-.49i -.00-.98i -.85+.49i

As we can see in the results, two of the inverted AR roots are almost equal to one, so in this case we apply the 12th difference of the series, this means that D=1. In this sense, the following table shows the correlogram of the new series which is D(log(GRE),1,12)

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The AF shows a value statically different from zero and the PAF is exponentially decaying to zero, this could mean the presence of a Moving Average process of first order (MA(1)). In this sense, the following chart shows the estimation output of the time
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series. As we can see, the inverted MA root is inferior to 1, in this sense, there is no need to make a modification (differentiate) of the time series.

Dependent Variable: D(LOG(GRE),1,12) Method: Least Squares Date: 01/21/10 Time: 22:36 Sample (adjusted): 1971M02 1989M12 Included observations: 227 after adjustments Convergence achieved after 7 iterations Backcast: 1971M01 Variable MA(1) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Inverted MA Roots Coefficient -0.516094 0.182529 0.182529 0.040481 0.370345 406.3747 .52 Std. Error 0.056979 t-Statistic -9.057687 Prob. 0.0000 -0.000361 0.044773 -3.571584 -3.556496 1.916350

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Durbin-Watson stat

2.2.

Estimation

Once we have specified the time series to estimate, we see the correlogram of the last regression in order to allow the identification of any order process.

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As we can see, the AF shows a coefficient statistically different from zero and the PAF shows that the twelve period coefficients (12, 24, and 36) are exponentially decaying to zero. In this sense, the correlogram show the presence of a seasonal moving average of order 12) and in order to confirm this, we estimate the previous equation including the SMA(12) as a regressor, the following chart shows the results for this estimation.
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Dependent Variable: D(LOG(GRE),1,12) Method: Least Squares Date: 01/21/10 Time: 22:51 Sample (adjusted): 1971M02 1989M12 Included observations: 227 after adjustments Convergence achieved after 12 iterations Backcast: 1970M01 1971M01 Variable MA(1) SMA(12) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Inverted MA Roots Coefficient -0.490891 -0.725088 0.409345 0.406720 0.034486 0.267588 443.2604 .97 .49+.84i -.49-.84i -.97 Std. Error 0.058300 0.041443 t-Statistic -8.420103 -17.49616 Prob. 0.0000 0.0000 -0.000361 0.044773 -3.887757 -3.857581 1.923616 .49 -.00+.97i -.84+.49i

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Durbin-Watson stat .84-.49i .49-.84i -.49+.84i .84+.49i .00-.97i -.84-.49i

In order to culminate this stage of the Box-Jenkins method, we need to check if the AR processes are stationary and if the MA ones are invertible, otherwise we would need to modify the values of d and D. However, in this case, we can see that there is no AR process and that the MA process is invertible.

Finally, we check that it possible to reject the null hypothesis in the individual significance tests associated with the fitted parameters.

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2.3.

Checking

Once we have estimated the final equation, the next step is to check if the residuals of the fitted model behave like a white noise process. In order to do this we apply a visual inspection of the residuals correlogram.

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The last two columns reported in the correlogram are the Ljung-Box Q-statistics and their p-values. The Q-statistic at lag k is a test statistic for the null hypothesis that there is no autocorrelation up to order k. .

.2 .1 .0 .15 .10 .05 .00 -.05 -.10 -.15 72 74 76 78 80 82 Actual 84 86 Fitted 88 -.2 -.1

Residual

30 25 20 15 10 5 0 -0.15 Series: Residuals Sample 1971M02 1989M12 Observations 227 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability -0.10 -0.05 0.00 0.05 0.10 -0.002511 0.001124 0.105467 -0.141326 0.034317 -0.179095 4.125722 13.19958 0.001361

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In this sense, the correlogram shows that we accept the null hypothesis and we can describe the residuals as white noise and the main statistics confirm that the expected value is almost zero and the Jarque-Bera test accepts the null hypothesis of normality.

Now that we have checked the results we can confirm that the Greek Industrial Production Index follows the following process:

ARIMA(0; 1; 1) x SARIMA(0;1;1) 2.4. Forecast

Once we have identified the process we can use it in order to forecast the following three years (1990, 1991 and 1992). The following graph show the results (blue line) and the confidence interval related with the forecast estimation (red lines).

140 130 120 110 100 90 80 70 60 90M01

90M07

91M01

91M07 _GREF

92M01

92M07

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3. MAIN CONLUSIONS The main objective of this work was to understand the behavior of the Greek Industrial Production Index. This objective was successfully achieved through the use of the BoxJenkins methodology.

In this work we used 240 observations of the monthly series (from January of 1970 to December of 1989). The Box-Jenkins method allowed us the identification and

estimation of the time series as an ARIMA(0; 1; 1) x SARIMA(0;1;1). These results were checked by the use of the residuals test which showed all the characteristics of a white noise (no autocorrelation, mean equal to zero and normality).

Finally, we use the model in order to forecast the value of the following three years (1990, 1991 and 1992) of the series.

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