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Problem Set 1 - Solutions

Multivariate Time Series


Spring 2017
Donato Ceci
donato.ceci@uniroma2.it

Exercise 1
Consider the n-dimension vector time series {Yt }.
Assuming stationarity, show that k = 0k where k = E[(Yt )(Ytk )0 ].

Solution

k = E[(Yt )(Ytk )0 ]
k k k

11 12 1n
k k k
21 22 2n
= .. .. .. ..
.

. . .
k k k
n1 n2 nn

We also know that:

k
ii = cov(yit , yitk ) = cov(yit , yit+k )
k
= ii
k
ij = cov(yit , yjtk ) 6= cov(yit , yjt+k )
k
6= ij

So that k 6= k . Instead, using stationarity of Yt we can derive the following:

k = E[(Yt )(Yt+k )0 ]
= E[(Ytk )(Ytk+k )0 ]
= E[(Ytk )(Yt )0 ]
0
= [E[(Yt )(Ytk )0 ]]
= 0k

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Exercise 2
Consider the following VAR(2) model of a n-vector of time series Yt :

Yt = 1 Yt1 + 2 Yt2 + t, (1)

where t are i.i.d. Nn (0, ) innovations.

i) Derive the expression for the coefficients of the Wold Representation;

ii) Compute the forecast of Yt+3 based on this representation and the corresponding MSE.

iii) Derive the companion form of model (1) and the forecast of Yt+3 in this framework.

Solution

i) Consider the polynomial (L) = In 1 L 2 L2 such that we can rewrite our model as (L)Yt = t .
Then the Wold polynomial (L) = (L)1 can be derived as (L)(L) = In in the following way:

(L)1 (L) = In
(In 1 L 2 L2 ) (0 + 1 L + 2 L2 + 3 L3 + ) = In + 0L + 0L2 + 0L3 +

0 1 0 L 2 0 l2 + 1 L 1 1 L2 2 1 L3 + 2 L2 1 2 L3 2 2 L4 + = In +

At this point we simply need to equate LHS coefficients with RHS coefficients of the same degree:

0 = In
1 0 + 1 = 0 1 = 1
2 0 1 1 + 2 = 0 2 = 1 1 + 2
2 1 1 2 + 3 = 0 3 = 1 2 + 2 1
2 2 1 3 + 4 = 0 4 = 1 3 + 2 2

ii)

Yt+3 = t+3 + 1 t+2 + 2 t+1 + 3 t +


Yt+3/t = 3 t + 4 t1 +
t+3/t = Yt+3 Yt+3/t
= t+3 + 1 t+2 + 2 t+1
M SE(t+3/t ) = E[t+3/t 0t+3/t ] = + 1 01 + 2 02

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iii) Rewrite the model as follow:
! ! ! !
Yt 1 2 Yt1 t
= +
Yt1 In 0n Yt2 0n

and define:
!
Yt
t =
Yt1
!
1 2
F =
In 0n

Then, using the chain rule for forecasting, we have:

t+3/t = F 3 t

Therefore:
! ! ! ! !
Yt+3 1 2 1 2 1 2 Yt
=
Yt+2 In 0n In 0n In 0n Yt1
! !
1 1 1 + 2 1 + 1 2 1 1 2 + 2 2 Yt
=
1 1 + 2 1 2 Yt1
! !
3 2 2 Yt
=
2 1 2 Yt1

and, if we continue in the substitution of the vector (Yt , Yt1 )0 , we are able to derive exactly the same
formula for Yt+3/t as in the Wold approach

Exercise 3
Consider the following VAR(p) model of a n-vector time series Yt :

A(L)Yt = ut ,

where A(L) is a polynomial matrix of order p, ut are i.i.d. Nn (0, ) innovations.

i) Derive the structural VAR (SVAR) representation of series Yt through the Cholesky decomposition of
the variance-covariance matrix .

ii) Explain how many restrictions on the SVAR parameters are required for the identification.

iii) Suppose that you have a VAR(p) for 3 variables: the inflation rate pt , the growth rate yt , and the
real exchange rate rt at which the domestic currency is exchanged for the one of the largest commercial
partner of the considered country. According to an economic reasoning, the three variables at hand

3
are respectively associated with a nominal shock, a real shock and a foreign shock. Explain how the 3
variables should be ordered in the structural VAR assuming that:

(a) pt is simultaneously affected by all the 3 shocks;


(b) rt is simultaneously affected by the international shock and the real one.

Solution

i) Using the Cholesky decomposition = P P 0 we can define the structural shock as t = P 1 ut (note
that both P and P 1 are lower triangular) so that:

0
E[t 0t ] = P 1 E[ut u0t ]P 1
0
= P 1 P P 0 P 1
= In (2)

so that we can define the SVAR as

BYt = BA1 Yt1 + + BAp Ytp + But


B = P 1

ii) The number of parameters in the Reduced Form model is given by:

n(n + 1)

2
2
A(L) pn

while from the SVAR we have:

Dn
B n(n 1)
(L) pn2

n(n1)
Therefore, the difference is 2 which represents the number of restrictions needed in order to
identify the SVAR.

iii) In order to derive the exact order let us first consider the Wold representation od the model

Yt = (L)B 1 t = (L)P t
= (L)t
X
= 0 t + k tk
k

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with 0 = B 1 = P 6= In and therefore lower triangular. Hence

y1,t p11 0 0 1,t
y2,t = p21 p22 0 2,t +

y3,t p31 p32 p33 3,t

and the order is as follow:



y1,t yt
y2,t = rt

y3,t pt

1,t realt
2,t = f oreignt

3,t nominalt