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Reading:
3.1
Distributed Lags
Distributed lags deal with the current and lagged effects of an independent variable
on the dependent variable. That is:
yt = + 0 xt + 1 xt1 + 2 xt2 + . . . + et
=+
i xti + et
i=0
tiplier);
The mean lag is
i=1
ii
P
j=0
i=1
iwi
The problem with the above model: an infinite number of coefficients. Two
feasible approaches are:
Assume i = 0 for i > some finite number.
Assume that i can be written as a function of a finite number of parameters
for all i = 1 to .
3.2
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2007,
Jonathan Yoder. All rights reserved
t-tests are usually not good for selecting lag length because lagged values of x
are likely to be highly correlated with current values. i.e. t-tests will have low
power.
Two better approaches, both based on the assumption that you know some
upper bound P for the lag length:
2 or minimizes the Akaike Info.
Choose the lag length p P that maximizes R
0
Criterion (AIC) = ln eTe + 2p
T .
Start with high P and do F-tests for joint significance of i . Successively drop
lags. Stop dropping lags as soon as Ho : i = 0i is rejected.
Both methods tend to overfit (leave too many lags in), so high significance
levels should be used for the F-test (e.g. = .01).
3.3
Two models, the Adaptive Expectations Model and the Partial Adjustment
Model have been used a great deal in the literature. They are two specific models
that imply a specific form of infinite distributed lag effects called Geometric lags.
3.3.1
Suppose the current value of the independent variables determines the desired value
or goal for the dependent variable:
yt = + xt + t ,
but only a fixed fraction of desired adjustment is accomplished in one period (it
takes time to build factories, restock diminished inventories, change institutional
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|| < 1.
rearrange:
yt = (1 )1 (1 L)yt
replace yt with the r.h.s. above and rearrange:
(1 L)yt = (1 )( + xt + t )
yt = (1 ) + (1 )xt + yt1 + (1 )t
t + yt1 + t
=
+ x
3.3.2
(1)
(1L) xt .
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X
= + (1 )
i xti + wt + t
yt = +
i=0
= + zt () + wt + t ,
= (1 )
yt = +
(1 )
xt + t
(1 L)
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3.4
yt = +
p
X
i yti +
r
X
i=1
j xtj + t ,
i.i.d t
j=0
C(L)yt = + B(L)xt + t ,
where
C(L) = 1 1 L 2 L2 p Lp and
B(L) = 0 + 1 L + 2 L2 + + r Lr
3.4.1
Estimation
yt = yt1 + t
yt =
yt1 =
X
t
=
i ti
1 L
i=0
i ti
i=1
So, yt1 is a function of t1 and all previous disturbances. The CLRM assumption
of E[0 X] = 0 holds if is i.i.d. (in this case X is lag y), because yt1 is not
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Jonathan Yoder. All rights reserved
3.4.2
Pr
B(1)
i i
P
i =
Long Run multiplier =
= A(1) =
p
C(1)
1
i i
i=0
where A(L) =
B(L)
C(L) .
y =
B1 (1)
B2 (1)
Bk (1)
+
X1 +
X2 + +
Xk
C(1)
C(1)
C(1)
C(1)
Consider an ARDL(2,1):
(0 + 1 L)
xt + t
(1 1 L 2 L2 )
B(L)
=
+
xt + t
C(L)
yt =
+
=
+ A(L)xt + t
=
+
i xt1 + t
i=0
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A(L)C(L) = B(L)
(0 + 1 L + 2 L2 + . . . )(1 1 L 2 L2 ) = (0 + 1 L)
(0 0 1 L0 2 L2 )+(1 L1 1 L2 1 2 L3 )+(2 L2 2 1 L3 2 2 L4 )+ = 0 +1 L
L0 :
0 = 0
L1 :
0 1 + 1 = 1
L2 :
0 2 1 1 + 2 = 0
L3 :
1 2 2 1 + 3 = 0
0 = 0
1 = 1 + 0 1
= 1 + 0 1
2 = 0 2 + 1 1
= 0 2 + (1 + 0 1 )1
3 = 1 2 + 2 1
= etc.
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3.4.4
Consider an ARDL(2,1):
yT +1 |yT = 1 yT + 2 yT 1 + 0 xT +1 + T +1
= 0 xT +1 + T +1 ,
where
xT +1 = yT
0
yT 1
xT +1
0
2
0
1
\
Var[e
xT +1 + s2 .
1 |T ] = xT +1 s (X X)
\
Var[e
1 |T ].
yT +1
T +1
yT 0
=
+0
y
0
T 1
..
..
.
.
0
p1
0
..
.
p yT
T +1
0
yT 1
0 yT 2 +
0
.
..
..
.
0
yT p
T +1 =
T +1 + CyT + T +1
y
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where
T +1 = + 0 xT +1 + + r xT +1r is known with certainty (so forecasts are
conditional on xT +1 ).
Cov[T +1 ] = E[(
yT +1 yT +1 )(
yT +1 yT +1 )0 ] =
0
.
..
where j = 1
2 0
0
= jj ,
.. . .
.
.
0
2 .
Note:
The forecast errors T +i are included above for intuition about the forecast
For T+2:
T +2 =
T +2 + CyT +1 + T +2
y
T +2 + C(
T +1 + CyT + T +1 ) + T +2
=
T +2 + C
T +1 + C2 yT + (CT +1 + T +2 )
=
Cov[CT +1 + T +2 )] = 2 (Cjj0 C0 + jj0 )
and Var[
yT +2 ] is the upper left element of 2 (Cjj0 C0 + jj0 ).
For F periods out
(normalize T to T = 0):
F
X
F = CF y0 +
y
F (f 1) + F (f 1) ]
Cf 1 [
f =1
"
Var[
yF ] =
jj +
F
1
X
#
i
i 0
[C ]jj [C ]
i=1
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Example: ARDL(2,1):
T +1 1
yT +1
+
=
1
0
yT
2 yT
yT 1
0
where
T +1 =
+ 0 xT +1 + 1 xT . Remember, for calculating forecasts, T +1 = 0.
3.4.5
An AR(1) model
yt = xt + vt ;
vt = vt1 + t
can be written as
yt = yt1 + xt xt1 + t
which is an ARDL(1,1) with a restriction on the coefficient on xt1 .
AR(p) as a restricted ARDL(p,p):
yt = xt + vt ,
where vt = 1 vt1 + + p vtp + t
vt R(L) = t .
yt = xt +
t
R(L)
R(L)yt = R(L)xt + t
C(L)yt = B(L)xt + t for C(L) = B(L).
Implications
1. Any AR(p) disturbance in a static model can be interpreted as a restricted
version of an ARDL(p,p).
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1 + 1 0 0
f (b) =
=
2 + 2 0
0
CFRs using characteristic roots.
ing the specification of ARDL models is based on the roots of the Lag operator
polynomials.
C(L) = (1 1 L 2 L2 )
B(L) = 0 (1 1 L 2 L2 )
= (1 1 L)(1 2 L)
= 0 (1 1 L)(1 2 L)
where i and i are characteristics roots (note, we just arbitrarily changed the signs
of 1 , 2 ). Then the ARDL(2,2) can be written as
or
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where ut =
t
1L
ARDL(1,1):
subtract yt1 :
add,subt. 0 xt1 :
yt = + yt1 + 0 xt + 1 xt1 + t
yt = + ( 1)yt1 + 0 xt + 1 xt1 + t
yt = + ( 1)yt1 + 0 xt + (0 + 1 )xt1 + t
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1
1
to get
yt = + 0 xt + ( 1)(yt1 xt1 ) + t ,
, where
B(1)
C(1)
where =
0 + 1
1
=
B(1)
.
C(1)
correction model, or more precisely, the error correction form of the ARDL(1,1)
model. One more step:
yt = 0 xt + [yt1 (
+ xt1 )] + t
where
=
= 1
and = ( 1). yt is comprised of two components (plus
0 = [yt1 (
+ xt1 )],
so
y =
+
x
Therefore, yt1 (
+ xt1 ) represents deviation from the equilibrium relationship
y=
+ x. 1 = ( 1) is the marginal impact of this deviation on yt .
Estimation: Assuming stationarity of y, all parameter of the ECM can be calculated based on estimates from the original ARDL(1,1) model. Alternatively, all
parameters of the ARDL(1,1) model can be calculated with the parameters from
the alternative specification
yt = 0 + 1 xt + 2 yt1 + 3 xt1 + t
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The results will be identical. Covariances can be calculated using the Delta method
if necessary. You could also estimate the ECM model parameters directly via nonlinear least squares.
3.5
Cointegration
3.5.1
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between y1 on y2 :
yit = y2t + t
y1t
= 1
y2t
t = y1t y2t
= (3t + ut ) (t + vt )
= (3 )t + (ut vt )
This is a linear combination of two I(1) variables, and so would in most cases
be I(1), and the variance if t would explode as t increases (i.e. not stationary).
However, if = 3, then the t is I(0) stationary, implying that y1 and y2
are cointegrated: integrated of the same order.
1 = 1 3 (or any multiple of it) is called a cointegrating vector
of y1t and y2t .
3.5.2
yt = 0 wt + yt1 + 0 xt + 1 xt1 + t
can be written as
yt = 0 wt + 0 xt + (yt1 xt1 ) + t
yt = 0 zt + 0 xt + zt + t
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If y and x are I(1), and wt are I(0), then is I(0) if zt = yt1 xt1 is
I(0).
Because is a function of the ARDL(1,1) parameters, a cointegrating relationship between the unrestricted ARDL parameters must hold for to be
stationary.
If such a relationship DOES hold, then will be stationary and we can estimate both the ARDL(1,1) form and the ECM form in a standard fashion
(OLS, NLS, with standard sampling distributions for the parameter estimates)
WITHOUT having to difference all the data.
If a cointegrating relationship does NOT hold, then the disturbance process
is not covariance stationary, and therefore the parameter estimates are not
covariance stationary, which means their sampling distributions are not stationary.
Note that when there is a cointegrating relationship, the regression above:
yt = 0 wt + 0 xt + zt + t
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3.5.3
(or I(0)) in the context of then the errors in a regression of one on the others
will be associated with a disturbance series that is I(0) . The Engle-Granger
cointegration test Proceed as follows:
Calculate a DF test statistic based on the errors from your hypothesized
regression: That is, run the regression
t = t1 +vt , and calculate
se(
) .
This test statistic does not have the same distribution as the usual DF test
statistic. You need to compare it to a different set of critical values developed
by Davidson and MacKinnon (1993) (Not shown in Greene).
If a unit root is not rejected, then no cointegration and inference relating to
model parameters based on that model is suspect.
Differencing of one thing or another is likely called for.
3.6
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112 y1t1 211
+
122
y2t1
221
212 y1t2 1t
+
222
y2t2
2t
or
yt = + 1 yt1 + 2 yt2 + t
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Where jml is the coefficient for the j th lag in the mth equation on the lth endogenous
variable.
Estimation: VARs are systems of regression equations with interrelated errors, so
SUR seems appropriate. However, because there are no cross-equation restrictions,
SUR is mathematically equivalent to OLS equation by equation.
3.6.1
Granger Causality
yt = yt1 + xt1 + t
GNP
t
1 1
= +
P OILt
2
1
2 GNPt1 3
+
2
P OILt1
3
4 GNPt2 1t
+
4
P OILt2
2t
first the restricted and unrestricted regressions of the first equation (GNP) alone; no
Page 109 WSU Econometrics II
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need to estimate the second equation for this test. Test stat distributed 2 (J = 2).
3.6.2
Impulse response functions track the effect of a single shock (from one or more
disturbance terms i ) on equilibrium values of y on the time path of y after the
shock.
y1t 1 111
= +
y2t
2
121
212 y1t2 1t
+
2t
222
y2t2
112 y1t1 211
+
122
y2t1
221
or
yt = + 1 yt1 + + p ytp + vt
(mx1)
(mx1)
(mxm) (mx1)
(mxm) (mx1)
(mx1)
For forecasting we can use the same Kalman filter arrangement as with the ARDL
Pp
model before: Recast the general model yt = + i i yti + vt as
yt1 0 I
. =.+ .
. . .
. . .
ytp+1
0
0
yt
0
..
.
0
yt2 0
. + .
0 .. ..
ytp
0
0
yt1
or
t =
+ (L)yt + vt .
y
let (L) = 1 L + 2 L2 , so that yt = + 1 yt1 + 2 yt2 + t can be written
as
yt = + (L)yt + vt .
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[I (L)]yt = + vt
yt = [I (L)]1 ( + vt )
1
= [I (L)]
i vti
+
y
i vti
+ [I (L)]1 vt
y
h + vi is R = h2 + v 2 .
What we are interested in is how a one-time shock flows through to the yi,t+j . In
general, a set of impulse response function and its covariance matrix is calculated
as
T +s = y
+ s vT
y
T +s =
s1
X
i ( 0 )i
i=0
0.461 y1t1 v1t
+ ;
0.297 y2t1
v2t
1 .5
= Cov[v1t , v2t ] =
.5 2
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Now, suppose a one unit change in v2t at t=0, such that v20 = 1. Then
y10 0
=
1
y20
0.461
y
0.008
0.461
y
10
11
=
=
0.297
0.232 0.297 y20
y21
2
y
0.008
0.461
y
0.008
0.461
y
0.141
12
11
10
=
=
=
y22
0.232 0.297 y21
0.232 0.297
y20
0.195
The covariance estimate for the two-period ahead impulse response is
1 .5 0.008
2 =
+
.5 2
0.232
0
0.461 1 .5 0.008 0.461
0.297 .5 2
0.232 0.297
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3.6.3
VAR can be applied to a set of nonstationary variables are and cointegrated (see
Davidson and Mackinnon section 14.5).
Consider the VAR with g endogenous variables Yt :
Yt = Xt B +
p+1
X
Yti i + Ut
i=1
where Yt are I(1), Xt are assumed I(0) deterministic variables, and B and i are
matrices of parameters to be estimated. This VAR can be reparameterized as
Yt = Xt B + Yt1 +
p
X
Yti i + Ut
i=1
Pp+1
i=1
i Ig . This
3.6.4
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3.6.5
Structural VARs
yt = + yt1 + t
where = 1 , = 1 , t = 1 vt , and Cov[t ] = [ 1 ] [ 1 ]0 .
Thus, we are simply back to simultaneous equation systems, but with the issues of
dynamics and simultaneity combined.
Example: Suppose that
1
=
21
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12
.
1
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Then we have a dynamic simultaneous equations problem, with all the lagged
dep. vars. being predetermined and therefore, for our purposes, exogenous.
Hsiao (1997) shows that if you have nonstationarity but cointegrating relationships in your model, then 2SLS and 3SLS can proceed as usual to address endogeneity.
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