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Non Stationary Phenomena/Time Series

Financial institutions and corporations as well as individual investors and researchers often use financial time series data (such as asset prices, exchange rates, GDP, inflation and other macroeconomic indicators) in economic forecasts, stock market analysis or studies of the data itself. Data points are often nonstationary OR HAVE MEANS, VARIANCES AND COVARIANCES THAT CHANGE OVER TIME. Nonstationary behaviors can be trends, cycles, random walks or combinations of the three. Non-stationary data, as a rule, are unpredictable and cannot be modeled or forecasted. The results obtained by using non-stationary time series may be bogus in that they may indicate a relationship between two variables where one does not exist. In order to receive consistent, reliable results, the non-stationary data needs to be transformed into stationary data. In contrast to the non-stationary process that has a variable variance and a mean that does not remain near, or returns to a long-run mean over time, the stationary process reverts around a constant long-term mean and has a constant variance independent of time.

Mathematical Definition/Formulas
Some series are called I(1) (integrated of order 1). These are non-stationary series whose first difference is stationary. A simple I(1) series is the “random walk,” where yt = yt−1 + €t , € is stationary so, by repeated substitution yt = €t + €t−1 + €t−2 + Note: series is called integrated because it is sum (integration) of all previous values of shocks Properties of random walks (and integrated series in general)

A non stationary process with a deterministic trend has a mean that grows around a fixed trend. Deterministic Trend (Yt = α + βt + εt ) Often a random walk with a drift is confused for a deterministic trend. but the value at time "t" in the case of a random walk is regressed on the last period's value (Yt-1). Random Walk with Drift and Deterministic Trend (Yt = α + Yt-1 + βt + εt ) Another example is a non-stationary process that combines a random walk with a drift component (α) and a deterministic trend (βt). or drift (α). Another characteristic of a random walk is that the variance evolves over time and goes to infinity as time goes to infinity. It also does not revert to a long-run mean and has variance dependent on time. a process with a unit root or a process with a stochastic trend. a random walk cannot be predicted. which is constant and independent of time. while in the case of a deterministic trend it is regressed on a time trend (βt). Both include a drift and a white noise component. which means εt is independent and identically distributed with mean "0" and variance "σ²".It specifies the value at time "t" by the last period's value. a trend . a drift. and a white noise term (εt).Conditions Real Life Examples Pure Random Walk (Yt = Yt-1 + εt ) Random walk predicts that the value at time "t" will be equal to the last period value plus a stochastic (non-systematic) component that is a white noise. It is a non mean reverting process that can move away from the mean either in a positive or negative direction. therefore. Random wal k can also be named a process integrated of some order. Random Walk with Drift (Yt = α + Yt-1 + εt ) If the random walk model predicts that the value at time "t" will equal the last period's value plus a constant. then the process is random walk with a drift.

see our Financial Concepts tutorial. (To learn more about random walks and trends.and a stochastic component.) .