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Lecture Notes 04 Ar 2

This document provides an overview of univariate stationary time series models, including autoregressive (AR) processes of order 1 and 2. It defines the AR(1) and AR(2) processes and their characteristic equations. It derives the moments, autocovariance functions, and stationarity/stability conditions for AR(1) and AR(2) processes. It also presents the Wold representation and discusses interpreting the dynamic effects using impulse response functions.

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153 views18 pages

Lecture Notes 04 Ar 2

This document provides an overview of univariate stationary time series models, including autoregressive (AR) processes of order 1 and 2. It defines the AR(1) and AR(2) processes and their characteristic equations. It derives the moments, autocovariance functions, and stationarity/stability conditions for AR(1) and AR(2) processes. It also presents the Wold representation and discusses interpreting the dynamic effects using impulse response functions.

Uploaded by

z_k_j_v
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Univariate Stationary Time Series Models

Applied Econometrics
by

Sunil Paul
Madras School of Economics

01-07-16

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Autoregressive Process
AR(1) process
I

A first order autoregressive process(without


constant):Yt = Yt1 + t , t WN(0, 2 )
Solution by recursive substitution:

Yt = Y0 +

t1

1 +

t2

t1
X
2 +...+t1 +t = Y0 +
i ti
t

i=0
I

Alternatively, solving forward j period from time t


Yt+j = j+1 Yt1 + j t + j1 t+1 + ... + t+j1 + t+j
= j+1 Yt1 +

j
X
i=0

Sunil Paul

Lecture Notes

i t+ji for j > 0

Univariate Stationary Time Series Models

Some Important Interpretations


I

Dynamic Multiplier (the effect of 1 on Yt ):


dYt+j
dt

dYt
dtj

= j , and

= j (The dynamic multiplier depends on j)

Explosive and stable system

Impulse response function(IRF): plot j against time j

Cumulative effect upto horizon j:


Pj
dYt+j
dYt+j
dYt+j
j
j1 + ... + + 1 =
j
i=o
dt + dt+1 + ... + dt+j = +

Long run
< 1):
i
h effect as j goes to (given||
dYt+j
dYt+j
dYt+j
2
lim
dt + dt+1 + ... + dt+j = 1 + + + .... =

1/(1 )

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Stability and Stationarity conditions

The AR(1) process is stable and stationary only if || < 1

If || < 1 then
I

lim j = 0

j
I

AR(1) can be expressed in wold form :Yt =


P
j=0 || = 1/(1 ) <

j=0

j tj

Remember
if || = 1 then AR(1) is a random walk and
P
j=0 || ( The process is not stable)

Sunil Paul

Lecture Notes

and

Univariate Stationary Time Series Models

AR(1) Process in Lag Operator Notation


I

(1 L)Yt = t

to get the wold form multiply both sides with (1 L)1

Note that if || < 1 then (1 L)1 = (1+ L + 2 L2 + ...)


(1 L)1 (1 L)Yt = (1 L)1 t

Yt = (1 + L + 2 L2 + ...)t = t + t1 + 2 t2 + ...
I

For stability root of (1 L) should be greater than one,


L = (1/) > 1. or < 1.

If = 1 its is unit root case, if > 1 then the process is


explosive and has unbounded mean and variance.
Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

AR(1) Process with drift

Yt = c + Yt1 + t , t WN(0, 2 )

Solution to this equation is:


Yt = t Y0 + c

t1
X
i=0

i +

t1
X

i ti

i=0

Pt
i
Assuming
||
<
1
we
have:Y
=
c/(1

)
+
t
i=0 ti with
P
j=0 || < ( i.e. the process converges if and only if lies
strictly inside the unit interval)

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Moments of Stationary AR(1) Process with drift

= E [Yt ] = c/(1 )

0 = E (Yt )2 = E (t + t1 + ...)2 =
(1 + 2 + 4 + ...) 2 = 2 /(1 2 )
I

Pt
Pt
Note that both E [Yt ] = c i=0 i and var [Yt ] = 2 i=0 2i
will be finite and independent of time only if || < 1..

j = E (Yt )(Ytj ) = E (t + t1 + 2 t2 + ... +


j tj + j+1 tj1 + ...) (tj + tj1 + 2 tj2 + ...) =
(j + j+2 + j+4 + ...) 2 = j [1 + 2 + 4 + ...) 2 =
[j /(1 2 )] 2

j = j /0 = j

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Moments of Stationary AR(1) Process with drift

We can also derive moments of AR(1) process by using


stationarity properties:

E (Yt ) = c + E (Yt1 ) + E (t ) = c + E (Yt ) = E (Yt ) =


c/(1 ) = [Stationarity means E (Yt ) = E (Yt1 )]

Solving the expression = c/(1 ) for c we get


(1 ) = c

Substituting this into Yt = c + Yt1 + t we have


Yt = (1 ) + Yt1 + t = Yt = (Yt1 ) + t

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Moments of Stationary AR(1) Process with drift

To get variance square the above expression and take


expectation on both sides:E (Yt )2 =
2 E (Yt1 )2 + E (t )2 + 2E [(Yt1 )t ]

Assuming stationarity we get


E (Yt )2 = E (Yt1 )2 = 0 = 2 0 + 2 + 0.

Hence 0 = 2 /(1 2 )

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Moments of Stationary AR(1) Process with Drift

To get autocovariance multiply Yt = (Yt1 ) + t


with Ytj on both sides and take expectations

i.e. E [(Yt )(Ytj )] =


E [(Yt1 )(Ytj )] + E [t (Ytj )]

Thus j = j1 and this is a first order diffidence equation

By solving we get j = j 0 = j [ 2 /(1 2 )](For instance;


2 = 1 , since1 = 0 , 2 can be writen as2 0 )

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Moments of Stationary AR(1) Process with drift

j
0

= j

Autocorrelation:j =

Half life (speed of mean reversion): lag at which IRF


decreases by one half, j = ln(0.5)
ln() [ take the log and rearrange
j
the equation = 0.5]

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Autocovarice generating function


The ACVGF of an AR(1)can be constructed as follows

gY (z) = (z)(z 1) =

1
1 z



1
1 z 1

= 2 (1 + z + 2 z 2 + ...) + (1 + z 1 + 2 z 2 + ...)




X

1
1 +
= 2
j z j + z j
2
1
j=1

Thus


j =

Sunil Paul

2 j
1 2

Lecture Notes

Univariate Stationary Time Series Models

AR(2) process

Yt = c + 1 Yt1 + 2 Yt2 + t or
(1 1 L 2 L2 )Yt = c + t .

Stationarity and stability conditions can be specified in terms


of the roots of lag polynomial (1 1 L 2 L2 ) = 0 (require
the roots to lie outside the unit circle)

The solution to the characteristic equation can be obtained by


factoring the quadratic equation into (1 1 L)(1 2 L) = 0,
where 1 + 2 = 1 and 1 2 = 2

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

AR(2) Process

In general we have a characteristic equation by replacing L


with z : (1 1 z 2 z 2 ) = (1 1 z)(1 2 z) = 0

The roots of
the quadratic characteristic
equation

1 21 +42
1 + 21 +42
, z2 =
are:z1 =
22
22
q
The roots can be real if 21 + 42 0 or complex if
q
21 + 42 < 0

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Moments of Stationary AR(2)


I

E (Yt ) = c + 1 E (Yt1 ) + 2 E (Yt2 ) + E (t )

Assuming stationarity we get


= c + 1 + 2 + 0 = = c/(1 1 2 )

Substituting the value of c from the above equation into


Yt = c + 1 Yt1 + 2 Yt2 + t we get
(Yt ) = 1 (Yt1 ) + 2 (Yt2 ) + t

For variance multiply both sides with (Yt ) and take


expectations on both sides:

E (Yt )2 =
1 E (Yt1 )(Yt )+2 E (Yt2 )(Yt )+E (t )(Yt )
I

i.e. 0 = 1 1 + 2 2 + 2

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Moments of Stationary AR(2)


I

For auto covariance multiply both sides with (Ytj ) and


take expectations on both sides:

E (Yt )(Ytj ) = 1 E (Yt1 )(Ytj ) +


2 E (Yt2 )(Ytj ) + E (t )(Ytj )
I

j = 1 j1 + 2 j2 for j = 1, 2, ....[Yule Walker equations]

To get autocorrelation j divide both sides of j by


0 : j = 1 j 1 + 2 j 2 for j 6= 0
I
I

0
1
1
2

=1
= 1 + 2 1 ( using the fact 1 = 1 ),thus
= 1 /(1 2 )
= 1 1 + 2

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Wold Representation of Stationary AR(2) process

(11 L2 L2 )Yt = c +t . = (11 L)(12 L)Yt = c +t .

Operating both sides of this equation


by(1 1 L)1 (1 2 L)1 we get:
I
I

Yt = (1 1 L)1 (1 2 L)1 c + (1 1 L)1 (1 2 L)1 t or


Yt = (L)c + (L)
t where (L)
P j j P j j 
=

L
is the inverse of (1 1 L 2 L2 )
j=0 1
j=0 2 L

Sunil Paul

Lecture Notes

Univariate Stationary Time Series Models

Reference

Hamilton, Time series analysis Chapters 1,2 and 3

Sunil Paul

Lecture Notes

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