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    Econ0022 Problem Set 3

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    Lucas X. Li
    This document provides an economics problem set on macroeconomic forecasting techniques. It includes questions on: 1) Analyzing the behavior of iterative forecasts from an AR(1) model in stationary and non-stationary cases. 2) Forecasting unemployment and inflation using a joint ADL/VAR model. 3) Proving properties of mean squared forecast errors. 4) Choosing an appropriate AR model order for forecasting US GDP growth using information criteria, pseudo-out-of-sample forecasting, and comparing forecast accuracy.

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    Econ0022 Problem Set 3

    Uploaded by

    Lucas X. Li
    63 views4 pages
    This document provides an economics problem set on macroeconomic forecasting techniques. It includes questions on: 1) Analyzing the behavior of iterative forecasts from an AR(1) model in stationary and non-stationary cases. 2) Forecasting unemployment and inflation using a joint ADL/VAR model. 3) Proving properties of mean squared forecast errors. 4) Choosing an appropriate AR model order for forecasting US GDP growth using information criteria, pseudo-out-of-sample forecasting, and comparing forecast accuracy.

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    This document provides an economics problem set on macroeconomic forecasting techniques. It includes questions on: 1) Analyzing the behavior of iterative forecasts from an AR(1) model in stationary and non-stationary cases. 2) Forecasting unemployment and inflation using a joint ADL/VAR model. 3) Proving properties of mean squared forecast errors. 4) Choosing an appropriate AR model order for forecasting US GDP growth using information criteria, pseudo-out-of-sample forecasting, and comparing forecast accuracy.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    63 views4 pages

    Econ0022 Problem Set 3

    Uploaded by

    Lucas X. Li
    This document provides an economics problem set on macroeconomic forecasting techniques. It includes questions on: 1) Analyzing the behavior of iterative forecasts from an AR(1) model in stationary and non-stationary cases. 2) Forecasting unemployment and inflation using a joint ADL/VAR model. 3) Proving properties of mean squared forecast errors. 4) Choosing an appropriate AR model order for forecasting US GDP growth using information criteria, pseudo-out-of-sample forecasting, and comparing forecast accuracy.

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    ECON0022

    Econometrics for Macro and Finance


    Problem Set III
    Dennis Kristensen

    Autumn 2018

    1 Practice Problems
    1. Consider iterative forecasts over the horizon T + 1; :::; T + h using an AR(1)
    model, Yt = + Yt 1 + "t , given data up to time T . We ignore parameter
    uncertainty and treat the parameters and as known such that the iterative
    forecast takes the form

    YT +kjT = + YT +k 1jT ; k = 1; 2; :::; h;

    where YT jT = YT . We wish to analyze the behaviour of the forecasts in the


    stationary (j j < 1) and non-stationary ( = 1) case.

    (a) Show that the …nal h-step ahead forecast, YT +hjT , can be expressed as
    n o
    YT +hjT = h YT + 1 + + 2 + ::: + h 1 :

    [hint: Use backward recursion starting at time T + h and stopping at time


    T]
    (b) Use the above expression to argue that for long-horizon forecasts (h very
    large):

    If j j < 1 : YT +hjT = Y;
    1
    If = 1 : YT +hjT ! 1;

    where YT +hjT ! 1 should be interpreted as YT +hjT exploding (increas-


    ing in absolute value without any bound) as h ! 1. Interpret the above
    results.
    (c) Let eT +h be h-step ahead forecast error de…ned as:

    eT +h = YT +h YT +hjT :

    Expresss eT +h as a function of "T +1 ;P


    :::; "T +h . [Hint: Use backward recur-
    sion to show that YT +h = YT +hjT + hi=01 i "T +h i ]

    1
    (d) Show that
    n o
    2 2 2(h 1)
    E [eT +h ] = 0; Var (eT +h ) = " 1+ + :::: :

    What is the h-step MSFE for the iterative procedure using an AR(1)
    model? What happens to the MSFE as h grows large?
    (e) Explain how you could use the results in question (d) to construct a 95%
    forecast interval for your h-period ahead point forecast.

    2. Suppose we have obtained the following estimates of an ADL model for annual
    US unemployment (unemp) using in‡ation (inf l) as additional preditor,

    d t = 1:304 + :647unempt
    unemp 1 + :184inf lt 1; ^ " = :883: (1)
    (:490) (:084) ((:041)

    (a) Suppose that unemp2012 = 7:8 and inf l2012 = 1:3. What is your forecast
    of unemployment in 2013?
    (b) Suppose the errors in the ADL model are normally distributed. Compute
    a 95% and 67% forecast interval.
    (c) Can you use the above ADL model to forecast employment for 2014?
    Explain.
    (d) You decide to build a model for in‡ation in addition to the above model
    for unemployment. You …nd that an AR(1) model provides an adequate
    description of in‡ation,
    c lt = 1:277 + :665inf lt
    inf 1; ^ " = :653: (2)
    (:558) (:107)

    Use eqs. (1)-(2) to compute a forecast of in‡ation and unemployment for


    2014.
    Note: the joint model for inf l and unemp as given in eqs. (1)-(2) is
    a particular example of so-called Vector Autoregressive (VAR) models.
    These allow for joint modelling of multiple economic time series.

    3. Prove the following results:

    (a) Let W be a random variable with mean W and variance 2 . Show that
    W
    for any constant c:
    h i
    E (W c)2 = 2W + ( W c)2 :

    (b) Consider the problem of forecasting YT +1 using data on YT ; YT 1 ; :::. Let


    denote fT +1jT denote some forecast of YT +1 based on YT ; YT 1 ; ::: Let
    h i
    2
    M SF E = E YT +1 fT +1jT

    2
    denote the unconditional mean squared forecast error associated with
    fT +1jT . Show that M SF E is minimized w.r.t. fT +1jT at fT +1jT = E [YT +1 ].
    Interpret the result.
    (c) Consider instead the conditional mean squared forecast error associated
    with fT +1jT ,
    h i
    2
    M SF ET = E YT +1 fT +1jT jYT ; YT 1 ; ::: :

    Show that M SF ET is minimized w.r.t. fT +1jT at fT +1jT = E [YT +1 jYT ; YT 1 ; :::].


    Interpret the result.
    (d) Which of the two forecasts, fT +1jT or fT +1jT , would you rather use? Ex-
    plain.

    4. Let Yt = log (GDPt ) be change in US log-GDP using USMacro_Quarterly.dta


    available on Moodle under "Data Sets". The goal is to choose an appropri-
    ate AR model for forecasting. After opening the data set in STATA, …rst set
    time [tsset time] and then create Yt [gen lgdp = log(realgdp); gen dlgdp
    =lgdp - L.lgdp].

    (a) As a …rst way of choosing the number of lags for the AR model for Yt ,
    compute the AIC and BIC and LR criteria for the given sample [this can
    be done with the STATA command varsoc dlgdp - note that STATA call
    the BIC criterion SBIC]. Which model(s) does each of the three criteria
    recommend?
    (b) As a second way of choosing the appropriate number of lags, we can use
    the pseudo-forecast evaluation criterion.
    To this end, we wish to compute rolling pseudo-forecasts as described in
    the slides. To perform this in STATA, you need to use the STATA com-
    mands that you …nd in the …le ’rolling forecast US-dgp.txt’ posted
    on Moodle/Problem Sets which performs the forecast evaluation using an
    AR(3) model.
    The …rst part of the code says:
    //Pseudo-forecast of dlgdp using AR(3) model for T=150,...,252.
    gen f_dlgdp3=.
    local start 150
    local end 252
    forv T=‘start’/‘end’ {
    quietly regress dlgdp L(1/3).dlgdp in 1/‘T’
    quietly replace f_dlgdp3 = _b[_cons] + _b[L1.dlgdp]*dlgdp[‘T’]
    + _b[L2.dlgdp]*dlgdp[‘T’-1] + _b[L3.dlgdp]*dlgdp[‘T’-2] in ‘T+1’/‘T+1’
    The above code runs a loop over T = 150; 151; :::; 252, where for each value
    of T STATA does the following:

    3
    i. Estimate an AR(3), Y^t = ^ T + ^ 1;=t Yt 1 + ^ 2;T Yt 2 + ^ 3;T Yt 3 , using
    only observations fY1 ; :::; YT g.
    ii. Compute Y^T +1jT = ^ T + ^ 1;T YT + ^ 2;T YT 1 + ^ 3;T YT 2 and save this
    value in f_dlgdp3.
    To perform steps (i)-(ii), copy the above part of the code from ’rolling
    forecast US-dgp.txt’and paste it into the command prompt in STATA
    (and press enter...).
    If you open the Data Editor, you’ll see that the variable f_dlgdp3 has
    been created containing the rolling pseudo-forecasts, Y^T +1jT .
    (c) To visualize the performance of the AR(3) as forecast model, plot the
    actual observed value of YT +1 together with its pseudo-forecasts. This can
    be done with the command ’tsline dlgdp f_dlgdp3 if tin(1984q2,)’.
    Does the AR(3) model appear to do a good job?
    (d) Next, compute pseudo-RMSFE in STATA by de…ning a new variable which
    is the di¤erence between by Y and Y^ , and compute its sample variance
    [gen e3 = dlgdp - f_dlgdp3; summarize e3]
    (e) Next, re-do questions (b)-(c), this time using an AR(1) model. This can
    be done by copy-pasting the second part of the code in the txt …le rolling
    forecast US-dgp.txt into the command line in STATA. This generates a
    new variable f_dlgdp1 that contains the rolling forecasts using an AR(1)
    model. Plot this new forecast vs. actual outcome, and compute the cor-
    responding pseudo-RMSFE.
    (f) We now have two pseudo-RMSFE’s - one using an AR(1) model, and one
    using an AR(3) model. In terms of pseudo-RMSFE, which of the two
    models would you recommend? How does this recommendation compare
    to the model(s) chosen by AIC, BIC and LR, respectively, in question (a)?

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