EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007

DEPARTMENTOFECONOMICS MEHMETBALCILAR

ECON604EVIEWSTUTORIAL#2
IDENTIFYINGANDESTIMATINGARMAMODELS

Note:WewilluseEViews5.1inthistutorial.TheremaybeminordifferencesinEViews6.
PreliminaryAnalysis

InthistutorialwewillidentifyandestimateanARMAmodelforthequarterlychangein
businessinventories,statedatannualratedinbillionsofdollars.Wehave60observations
coveringtheperiod1955.1to1969.4.Thedataisavailableatthecoursewebpage.Firstobtain
thedatafilebusiness_inventory.wf1andopenit.

Selecttheseriesinventoryintheworkfile,thenselect[Quick/Graph/Linegraph]:

Typeinventoryintheboxifitisnotalreadywritten:

EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007
DEPARTMENTOFECONOMICS MEHMETBALCILAR

ClickOK,youshouldseethefollowinggraph

-8
-4
0
4
8
12
16
20
1956 1958 1960 1962 1964 1966 1968
Change in Business Inventories
Acausalexaminationofthegraphsuggeststhattheseriesisstationary(noapparenttrend,and
nochangeinvolatility).Theobservationsseemtofluctuatearoundafixedmean,andthe
varianceseemstobeconstantovertime.
Identification

Closethegraph,andopentheinventoryseriesbydoubleclickingontheinventoryinthe
workfile.Click[View],select[Correlogram]andtype15intheLagstoincludebox,andclickOK.
BoxandJenkinks(1976)suggestthatmostautocorrelationswemaysafelyexamineisabout
onefourthofthenumberofobservations.With60observationswemaycalculate60/4=15
2

EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007
DEPARTMENTOFECONOMICS MEHMETBALCILAR

x
t
= c +
1
x
t-1
+ e
t

or
autocorrelations.Now,youshouldseetheACF,PACF,theportmanteauQstatistics,anditsp
valueinthefollowingwindow.

ConsidertheestimatedACFintheabovefigure.Onlythefirst6autocorrelationsare
significantlydifferentfromzeroat5%level:onlythefirstfiveautocorrelationsextendbeyond
the95%confidenceintervalsindicatedbydashedlines.Theautocorrelationsdecaytostatistical
insignificanceratherquickly.Weconcludethatthemeanoftheseriesisprobablystationary.An
ARmodelseemsappropriatebecausetheACFdecaystowardzeroratherthancuttingoff
sharplytozero.IftheACFcutsofftozero,itsuggestsamovingaveragemodel.

AdecayingACFisalsoconsistentwithamixedARMAmodel.Butstartingwithamixedmodelis
oftenunwiseforthreereasons.First,itisoftendifficulttocorrectlyidentifyamixedmodel
initially.Mixednatureofthemodelismorelikelytobedetectedatthediagnosticstage.Second,
theprincipleofparsimonysuggeststhatwefirsttryasimpleARorMAmodelbefore
consideringamixedmodel.Finally,startingimmediatelywithamixedmodelmayresultin
parameterredundancy(orcommonfactorsproblem).

WeattentivelyproposeanARmodel.ExperienceandtheshapeofthePACF,whichcutsoffto
zeroafterlag1,suggestthatweshouldconsiderp=1orp=2asaninitialchoice.ThePACF
cutsofftozeroafterlagone,soitismorelikelythatwehaveanAR(1)model.Thus,wesuggest
toestimatethefollowingmodel:
EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007
DEPARTMENTOFECONOMICS MEHMETBALCILAR

x
t
- p =
1
(x
t-1
- p) + e
t

z
t
=
1
z
t-1
+ e
t

herez
t
= x
t
- p.
Estimation
teanAR(1)modelassuggestedbytheACFandPACF.Wewillestimatethe
d
l,select[Quick/
,here
Dependent Variable: INVENTORY
st Squares

Q2 1969Q4
r adjustments
ns
w
Wefirstestima
interceptcand
1
simultaneouslynotethatp = c(1 -
1
),sowecanrecoverfromcan
viceversa.InorderestimatetheAR(1)mode EstimateEquation]andtype
inventorycar(1),andclickOK.InEViewsar(k)standsforthekthlagofthemodeledseries
inventory.Thatisar(k)=inventory
tk
.Youshouldgetthefollowingestimationoutput:

Method: Lea
Date: 10/18/07 Time: 21:32
Sample (adjusted): 1955
Included observations: 59 afte
Convergence achieved after 3 iteratio
Variable Coefficient Std. Error t-Statistic Prob.
C 6.191556 1.418264 4.365588 0.0001
AR(1) 0.689752 0.095688 7.208318 0.0000
R-square M den 6.
Adjusted R-squared 0.467694 S.D. dependent var 4.631390
ssion
d 0.476872 ean depen t var 123729
S.E. of regre 3.379030 Akaike info criterion 5.306365
Sum squared resid 650.8172 Schwarz criterion 5.376790
Log likelihood -154.5378 F-statistic 51.95985
Durbin-Watson stat 2.095747 Prob(F-statistic) 0.000000
Inverted AR Roots .69

Click[Name]andtypeeq_ar1forthenametosavethismodelasanEViewsequationforlater
,
`
6.191SS6 = 1.92u918
use.Inthisoutput,itisveryimportanttonotethatEViewsreportsp ratherthanc asan
estimateoftheintercept.HeretheestimatedAR(1)parameteris
`
1
= u.6897S2 whilethe
estimatedinterceptisgivenbyc = (1 -
1
)p = (1 - u.6897S2) .
EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007
DEPARTMENTOFECONOMICS MEHMETBALCILAR

`
1
| < 1
0
:
1
= u
t =

`
1
- u
se(
`
)
Themodelcertainlysatisfythestationaryrequirement| .TheestimatedAR(1)
parameterisalsosignificantlydifferentfromzerosinceforthehypothesisE ,thet
statisticisgivenby
=
u.6897SS
u.u9S688
1
= 7.2u8S18
q 2
ForinstanceinordertoestimatetheARMA(2,1),select[Quick/EstimateEquation]andtypethe
andmuchlargerthanthecriticalvalue2.0.TheSchwarzinformationcriterionforthismodelis
5.3768.InordertocomparewithARMA(p,q)modelswithp, ,weestimateeach
combinationanreportthecorrespondingSchwarzinformationcriterioninthefollowingtable.
WenotethatinorderestimateamovingaveragetermtheEViewskeywordma(k)shouldbe
use,wherekisthelag.Forinstancema(1)=
t
.Inorderestimatethesemodels,weproceedasin
theprecedingcasebyreplacingtheequationtoestimateasfollows:
AR(2): inventorycar(1)ar(2)
MA(1): inventorycma(1)
MA(2): inventorycma(1)ma(2)
ARMA(1,1): inventorycar(1)ma(1)
ARMA(2,1): inventorycar(1)ar(2)ma(1)
ARMA(1,2): inventorycar(1)ma(1)ma(2)
ARMA(2,2): inventorycar(1)ar(2)ma(1)ma(2)
equationasfollows:

Thisshouldgivethefollowingestimationoutput:
EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007
DEPARTMENTOFECONOMICS MEHMETBALCILAR

Dependent Variable: INVENTORY
Method: Least Squares
Date: 10/18/07 Time: 22:34
Sample (adjusted): 1955Q3 1969Q4
Included observations: 58 after adjustments
Convergence achieved after 12 iterations
Backcast: 1955Q1 1955Q2
Variable Coefficient Std. Error t-Statistic Prob.
C 6.302821 1.896556 3.323298 0.0016
AR(1) 0.153273 0.491479 0.311860 0.7564
AR(2) 0.557357 0.353897 1.574911 0.1212
MA(1) 0.474353 0.492646 0.962868 0.3400
MA(2) -0.271391 0.193717 -1.400967 0.1671
R-squared 0.495501 Mean dependent var 6.129310
Adjusted R-squared 0.457426 S.D. dependent var 4.671639
S.E. of regression 3.441112 Akaike info criterion 5.391729
Sum squared resid 627.5862 Schwarz criterion 5.569353
Log likelihood -151.3601 F-statistic 13.01370
Durbin-Watson stat 1.970862 Prob(F-statistic) 0.000000
Inverted AR Roots .83 -.67
Inverted MA Roots .34 -.81

WeobtainthefollowingSchwarzinformationcriteria(SC)forthesemodels

AR(1): 5.376790
AR(2): 5.453999
MA(1): 5.557594
MA(2): 5.560201
ARMA(1,1): 5.432318
ARMA(2,1): 5.450277
ARMA(1,2): 5.493857
ARMA(2,2): 5.391729
TheminimumSCvalueisobtainedfortheAR(1)model.Thusweconsiderthismodelastheideal
candidate.Ournextstepistocheckitsappropriateness.
EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007
DEPARTMENTOFECONOMICS MEHMETBALCILAR

DiagnosticChecking
TodetermineiftheAR(1)modelisstatisticallyadequate,wefirstcompareitstheoreticalACF
andPACFtoempiricalACFandPACFofthedata.Nowopeneq_ar1andclick[View]andchoose
[ARMAStructure/Correlogram],type15fortheLagsandclickOK:

Weobtainthefollowinggraphics:

.0
.2
.4
.6
.8
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Actual Theoretical
A
u
t
o
c
o
r
r
e
l
a
t
i
o
n
-.2
.0
.2
.4
.6
.8
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Actual Theoretical
P
a
r
t
i
a
l

a
u
t
o
c
o
r
r
e
l
a
t
i
o
n

EASTERNMEDITERRANEANUNIVERSITY ECON604,FALL2007
DEPARTMENTOFECONOMICS MEHMETBALCILAR

E
0
: p
1
= p
2
= = p
15
= u
Clearly,thetheoreticalACFandPACFmatchesallthesignificantsampleACFandPACF
estimates.TheAR(1)modelproducesquitesimilarautocorrelationfunctionwithamergingof
samplingerror.
Aseconddiagnosticcheckwewilldoistheindependenceoftherandomshocktermst.In
ordertocheckthis,weuseresidualautocorrelationfunction.Click[View],chose[Residual
Tests/CorrelogramQstatistics],andtype15intheboxforLagstoinclude.Weobtainthe
followingpicture:

TheLjungBoxQstatisticforthetesting
is8.5291withapvalueof0.860.Theindependenceofrandomshocksiscertainlynotrejected
evenat15lags.Wealsonotethatallresidualautocorrelationestimatesarewithinthe95%
confidenceintervals.WesafelyassumethatrandomshocktermiswhitenoiseunderanAR(1)
model.Therefore,AR(1)modelisappropriateforthequarterlychangesinbusinessinventories.