Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime...
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Time Series Techniques & ApplicationsPeter C. B. Phillips
Modeling Trends, Trend Extraction, Automated Discovery
1. (2003).“Laws and Limits of Econometrics”, Economic Journal, 113, C26-C52..
2. (2005). “Challenges of Trending Time Series Econometrics”,Mathematics and Com-
puters in Simulation, 68, 401-416.
3. (2005). “Automated Discovery in Econometrics”. Econometric Theory, 21, 3-20.
4. (2009). “Econometric Theory and Practice”. Econometric Theory, 25, 583-586.
5. (2010). “The Mystery of Trends”. Macroeconomic Review, October Issue
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Some of the Biggest Issues in Economics and Finance concern Trend
² Macroeconomics:
— the process of economic growth
— the study of growth convergence + divergence
— emergent peaks
— evolution in the distribution of world income
— trends in world consumer culture/transportation
² Finance:
— reconcilingmartingalemodels of efficient price determinationwith long run growth
and long run predictability
— modeling and predicting financial bubbles
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Trends in Kernel Density Estimates of Distribution of per capita GDP in constant US
dollars over 119 Countries (Bianchi, 1997, JAE)
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5000 15000 25000
Number of Observastions
1
2
3
4
RV
X10
000
Noise function for AA from Consolidated
5000 15000 25000
Number of Observastions
0
1
2
3
4
5
6
RV
X10
000
Noise function for GE from Consolidated
Market microstructure noise functions for AA and GE. The horizontal axis is the
number of prices used to construct the realized volatility. The vertical axis is the
realized volatility. Consolidated market Trade prices (November 1, 2004 to November
24, 2004)
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And Other Fields
² Natural History
— paleodiversity + history of life
— origination and extinction of species
² Environmetrics
— atmospheric pollution
— climate change
— deforestation, ozone depletion, exotic afforestation
² Human characteristics & demographics
— athletic records
— obesity
— life expectancy & trends in aging
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Climate Change
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Climate Change: ice core data
Vostok Ice Core Data
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cycle
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
![Page 12: Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime Series Techniques & Applications Peter C. B. Phillips Modeling Trends, Trend Extraction,](https://reader034.fdocuments.us/reader034/viewer/2022043000/5f758b99577f132a1f2deb5f/html5/thumbnails/12.jpg)
Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
![Page 13: Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime Series Techniques & Applications Peter C. B. Phillips Modeling Trends, Trend Extraction,](https://reader034.fdocuments.us/reader034/viewer/2022043000/5f758b99577f132a1f2deb5f/html5/thumbnails/13.jpg)
Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
![Page 14: Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime Series Techniques & Applications Peter C. B. Phillips Modeling Trends, Trend Extraction,](https://reader034.fdocuments.us/reader034/viewer/2022043000/5f758b99577f132a1f2deb5f/html5/thumbnails/14.jpg)
Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
![Page 15: Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime Series Techniques & Applications Peter C. B. Phillips Modeling Trends, Trend Extraction,](https://reader034.fdocuments.us/reader034/viewer/2022043000/5f758b99577f132a1f2deb5f/html5/thumbnails/15.jpg)
Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
![Page 16: Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime Series Techniques & Applications Peter C. B. Phillips Modeling Trends, Trend Extraction,](https://reader034.fdocuments.us/reader034/viewer/2022043000/5f758b99577f132a1f2deb5f/html5/thumbnails/16.jpg)
Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
![Page 17: Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime Series Techniques & Applications Peter C. B. Phillips Modeling Trends, Trend Extraction,](https://reader034.fdocuments.us/reader034/viewer/2022043000/5f758b99577f132a1f2deb5f/html5/thumbnails/17.jpg)
Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wandering
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
M
m
Multiple threshold turning point model
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
Xt a1 b1t Xt01
peakMexceededat ti
Xti M, Xti−1 M;
drift sustainedwhileXt−1m
Xt−1 m , t ≥ ti
M
m
Multiple threshold turning point model
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
Xt a1 b1t Xt01
peakMexceededat ti
Xti M, Xti−1 M;
drift sustainedwhileXt−1m
Xt−1 m , t ≥ ti
a2 b2t Xt01
troughm exceededat ti1
Xti1 m, Xti1−1 m;
drift sustainedwhileXt−1m
Xt−1 M , t ≥ ti1
M
m
Multiple threshold turning point model
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
Xt a1 b1t Xt01
peakMexceededat ti
Xti M, Xti−1 M;
drift sustainedwhileXt−1m
Xt−1 m , t ≥ ti
a2 b2t Xt01
troughm exceededat ti1
Xti1 m, Xti1−1 m;
drift sustainedwhileXt−1m
Xt−1 M , t ≥ ti1
M
m
Multiple threshold turning point model
further issues:• duration over M• duration below m
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning points
Xt a1 b1t Xt01
peakMexceededat ti
Xti M, Xti−1 M;
drift sustainedwhileXt−1m
Xt−1 m , t ≥ ti
a2 b2t Xt01
troughm exceededat ti1
Xti1 m, Xti1−1 m;
drift sustainedwhileXt−1m
Xt−1 M , t ≥ ti1
M
m
Multiple threshold turning point model
further issues:• duration over M• duration below m• many regimes• efficient estimation of drift
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning pointse. comovement with CO2
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning pointse. comovement with CO2 and Dust
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning pointse. comovement with CO2 and Dustf. causal anticipation
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Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning pointse. comovement with CO2 and Dustf. causal anticipation
![Page 31: Time Series Techniques & Applicationskorora.econ.yale.edu/phillips/teach/notes/lc-fall16.pdfTime Series Techniques & Applications Peter C. B. Phillips Modeling Trends, Trend Extraction,](https://reader034.fdocuments.us/reader034/viewer/2022043000/5f758b99577f132a1f2deb5f/html5/thumbnails/31.jpg)
Climate Change: ice core data
Vostok Ice Core Data
Modeling issues:a. irregular cycle & heterogeneity b. drift and random wandering within cyclec. regulated drift and random wanderingd. thresholds & turning pointse. comovement with CO2 and Dustf. causal anticipation
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Deep Sea Atlantic Drilling Data
Climate Change: drilling data
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Deep Sea Atlantic Drilling Data
Climate Change: drilling data
Colderas O18
increases
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Deep Sea Drilling Data
Climate Change: drilling data
Modeling issues:a. Longer term trends & embedding ice core data
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Deep Sea Drilling Data
Climate Change: drilling data
Modeling issues:a. Longer term trends & embedding ice core data
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Deep Sea Drilling Data
Climate Change: drilling data
Modeling issues:a. Longer term trends & embedding ice core data
Coolingtrendover3myr
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Deep Sea Drilling Data
Climate Change: drilling data
Modeling issues:a. Longer term trends & embedding ice core datab. Heterogeneity & measurement error
Coolingtrendover3myr
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Ideas and Motivation
Basic Properties of Economic & Financial Time Series & Panels
1. Temporal dependence (first and higher moments)
2. Joint dependence - endogeneity, cross correlation
3. Nonstationarity (secular growth, random wandering behavior, long memory)
4. Individual effects + time effects - panel characteristics
5. Volatility & conditional volatility - second moment modeling
6. Heavy tails & outlier activity (Pareto Law, Zipf law; power law probability)
(a) Income and wealth distributions in economics
(b) Company size in finance - frequency inversely proportional to rank
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Zipf Law (Harvard linguist - George Zipf)
f(k; s,N) =1ksPNn=1
1ns
Zipf Law probability function (log scale)
company size (few large multinationals, many small businesses)
statistical occurence of words in different languages (few special nouns, many articles)
internet trafffic & frequency of access to web pages
top income earners, earthquake size, human settlement size etc
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Hill Estimator of Tail Slope Parameter
1. Pareto Tail Shape
P (X > x)
P (X < ¡x)
9=; =
8<: axa
©1 + d
x¯+ o
¡1x¯
¢ªbxa
©1 + d
x¯+ o
¡1x¯
¢ª α, β, a, b > 0
2. Order Statistics
X1, X2, X3, ...., Xj, .....Xn
X(1) < X(2) < X(3) < .... < X(j) < ..... < X(n)
3. Hill Estimator of tail slope parameter
α =1
1m+1
Pmk=0 log
X(n¡k)
X(n¡m)
, m+ 1 largest observations
4. Limit distribution
pm (α¡ α)!d N
¡0, α2
¢,
1
m+m
2¯2¯+®
n! 0
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Source: Straumann, D. (2004). Estimation in Conditionally Heteroscedastic Time
Series Models. Springer. EWMA: σ2t = (1¡ λ)X2t + λσ2t¡1.
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Source: Straumann, D. (2004).
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Historical Daily Exchange Rate Data 1922-1925
Source: McFarland, J. W., P. C. McMahon and P. C. B. Phillips (1996). J. Applied
Econometrics, 11, 1-23.
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Empirical cdf & Tail Slope
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Tail Slope Estimates for Exchange Rate Data
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Nonstationarity + Joint Dependence in Panels
² How do we model nonstationarity and trend?
² Common convention (and convenience) of log regression on a linear trend
— measures average growth rate
— but no causal mechanism
— need to penalize fit
² In panel data
— often a multiplicity/richness of individual outcomes
— but some sense of common factor
² Suggests some mechanism of co-dependence + common engine of growth?
— cumulative sum - random wandering features are common
— dynamic factor & nonlinear factor modeling
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Examples
A: World income over 1950-2000 data sets:
Penn World Table data (http://pwt.econ.upenn.edu/)
OECD world Economic data
(http://www.theworldeconomy.org/publications/worldeconomy/statistics.htm)
References
a. Barro, R. J. (1997), Determinants of Economic Growth. Cambridge Press.
b. Barro, R. J. & X. Sala-i-Martin (1992). J. Political Economy, 100, 223-251.
c. Barro, R. J. & X. Sala-i-Martin (1995). Economic Growth. McGraw Hill
d. Phillips, P. C. B. &D. Sul (2004). Transition&EconomicGrowth, Cowles Discussion
Paper, Yale.
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5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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6
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8
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10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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y = 0.0214x - 32.483R2 = 0.9904
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
US Trend Growth
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y = 0.0536x - 97.109R2 = 0.9714
y = 0.0214x - 32.483R2 = 0.9904
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
US & Singapore Trend Growth
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6
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8
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10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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y = 0.0132x - 16.719R2 = 0.9485
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
New Zealand Trend Growth
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5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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y = 0.0381x - 67.367R2 = 0.9693
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
Malaysia Trend Growth
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6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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y = 0.0632x - 116.79R2 = 0.9855
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
South Korea Trend Growth
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5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
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y = -0.0106x + 28.885R2 = 0.0844
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
Iraq Trend Growth
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y = 0.0536x - 97.109R2 = 0.9714
y = 0.0214x - 32.483R2 = 0.9904
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
How Adequate is a Linear Trend in Modeling Growth?
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y = -4E-05x3 + 0.2462x2 - 486.59x + 320556R2 = 0.9914
5
6
7
8
9
10
11
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
Polynomial Trend Growth for Singapore - high on fit, low on realism.
Need to Penalize Fit
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B: Paleobiodiversity - History of Life - Example
Diversity, Origination, Extinction over 550 Million Years
² Marine fossil records - record new species (originations) & extinctions
² Total genera (Gi) appearing at some time during [ti, ti+1] in relation to number of
genera that first appeared (Oi) and number of genera that last appeared (Ei)
Gi+1 = Gi ¡ Ei +Oi+1
leading to
Gn = G1 +nXi=2
Oi ¡n¡1Xi=1
Ei
which has cumulative sum - random wandering features.
a. Sepkoski, J. J. (1997), J. Paleontology, 71, 533-539.
b. Cornette, J. L. and B. S. Lieberman (2004), Proc. Nat. Acad. Sci. 101, 187-191.
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Geological Chronology47
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Paleobiodiversity
0
1000
2000
3000
4000
5000
6000
7000
0100200300400500600
Million Years Ago
Diversity X 1000
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Paleobiodiversity + Linear Trend
0
1000
2000
3000
4000
5000
6000
7000
0100200300400500600
Million Years Ago
Diversity X 1000
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Paleobiodiversity
y = -4.8172x + 2900.7R2 = 0.5239
y = 0.0189x2 - 15.554x + 3917.9R2 = 0.6727
0
1000
2000
3000
4000
5000
6000
7000
0100200300400500600
Million Years Ago
Diversity X 1000
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Trends y = 1E-07x4 - 0.0003x3 + 0.2157x2 - 55.356x + 5730R2 = 0.94
0
1000
2000
3000
4000
5000
6000
7000
0100200300400500600
Million Years Ago
Diversity X 1000
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Species Origination
0
200
400
600
800
1000
1200
0100200300400500600Million Years Ago
Orig
inat
ionn
X
100
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Species Extinctions
0
200
400
600
800
1000
1200
1400
1600
0100200300400500600Miilion Years Ago
Extin
ctio
nss
X 10
0
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C: Social Trends - Divorce Rates
Effect of Societal Laws on Behavior
² Marital bargaining models (Becker, 1981)
² Empirical Trends in Divorce over US States (Wolfers, AER 2006)
a. effect of unilateral/no fault divorce laws
b. regime change — structural change in trend from consent divorce regime
c. dynamic responses over time to regime change
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Modeling and Understanding Trends
² Many possible functional forms - polynomial, trigonometric polynomial, exponential,
neural net
² Relatively easy to get decent fit
— but what use is it?
—What do the coefficients mean + how do we interpret them?
² Modeling data generating process:
— need to evaluate models + accommodate misspecification
— trend may well be stochastic in nature
— if so, how does deterministic modeling cope?
— is there a random walk or unit root in the history of life?
²When there is a trending panel - how to do we correlate the trends?
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Explicit Forms of Trend Function
1. Time Polynomial or power function form with residual
Xt =
pXi=0
aiti +X0
t ; Xt =
pXi=0
aitαi +X0
t
2. General Deterministic - nonparametric forms with residual
Xt = f (t) +X0t ; Xt = f
µt
n
¶+X0
t
3. Breaking Trends + partial + multiple breaks
Xt =
Ãp1Xi=0
a1i ti
!1 (t < n1) +
Ãp2Xi=0
a2i ti
!1 (t ¸ n1) +X0
t
4. Smooth Transition functions (e.g. STAR, VECM models)
∆Xt = Azt (β) +Bzt (β)F (qt, λ) + ut, F (qt, λ) =1
1 + e¡λ1(qt¡λ2)
zt (β) =¡β0Xt¡1,∆Xt¡1, ...,∆Xt¡p
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5. Decay Models - evaporating trends
Xt =β
tα+ ut, Xt =
β
L (t) tα+ ut, L (t) slowly varying at1
6. Nonlinear factor models with trend
Xit = δitμt, δit =
8<: δi +θi
L(t)t® +σiξitL(t)t® !p δi idiosyncratic paths
δ + θiL(t)t® +
σiξitL(t)t® !p δ common paths
μt = common trend/growth component
7. Explosive bubbles
Xt = θXt¡1 + ut,
8<: θ > 1 pure explosive process
θ = 1 + ckn
> 1, kn ! 1 mildly explosive process
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Common Stochastic Trends
1. Unit root (accumulated sum) model - I (1) process
∆Xt = ut; Xt =tX
s=1
us +X0
2. Multiple unit root model - I (2) process
∆2Xt = ut; or ∆Xt = vt, ∆vt = ut so that
Xt =tX
s=1
0@ sXj=1
us +∆X0
1A+X0
=tX
s=1
sXj=1
us + t∆X0 +X0
3. Long Memory model (fractional integration) - I (d) process
(1¡ L)d Xt = ut or
Xt =
8<:P1
j=0
(d)jj! ut¡j jdj < 1
2Ptj=0
(d)jj! ut¡j +X0 d ¸ 1
2
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Effects of Trend
1. Observed behavior: divergence of process, no fixed mean, secular growth, explosive
bubble, recurrence (visits every point in sample space)
2. Asymptotic form - standardized process (deterministic trend, semimartingale, Brown-
ian motion, fractional Brownian motion): f¡tT
¢» M (r) for t = [Tr] .
3. Changes in statistical theory and classical asymptotics (unit roots, cointegration,
singularity of moment matrix limits due to common trends, degeneracy of limit
theory, discontinuities in limit theory)
4. Importance of full trajectory + initialization
5. Prediction and prediction standard errors
6. Persistence of shocks, butterfly effects
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Trend Extraction
1. Smoothing and Filtering
A. The Hodrick Prescott -Whittaker Filter: fit a trend to data yn = fytgnt=1 by the
smoother
ft = argminft
8>>><>>>:nXt=1
(yt ¡ ft)2
| z best least squares fit
+
λnXt=2
¡∆2ft
¢2| z
penalty for roughness
9>>>=>>>; = ft (yn)
The fitted cycle is the residual
ct = yt ¡ ft
References
i Hodrick, R. J. and E. C. Prescott (1997), J. Money, Credit and Banking, 29, 1-16.
ii.Whittaker (1923). Proc. Edinburgh Math. Assoc. 78, 81-89..
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Notes on the WHP Filter:
1. ft depends on the full trajectory yn - it smooths the data yn.
2. As λ ! 1, the penalty rises, ft is smoother and eventually ft = a + bt is linear
3. As λ ! 0, the penalty is less important (more roughness is allowed) until ultimately
ft = yt and there is no smoothing.
4. λ = 1600 is often used in practical work with quarterly data
5. The solution satisfies the functional equation
ft =1
λL¡2 (1¡ L)4 + 1yt, ct =
λL¡2 (1¡ L)4
λL¡2 (1¡ L)4 + 1yt
6. Observe that if yt = (1¡ L)¡1 ut, so yt is I (1), then ct =λL¡2(1¡L)3
λL¡2(1¡L)4+1ut and ct is
apparently stationary.
7. Practical calculation of the WHP filter is usually by a numerical procedure.
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B. Band Pass Filtering
(a) i. Ideal filter to extract the business cycle in the data is a bandpass filter that
extracts components with periodic fluctuations in the business cycle frequency
- say between 6-32 quarters.
ii. Baxter and King find the best approximant time domain filter corresponding
to this (for frequencies greater than λ0) is:
b (L) =KX
h=¡KbhL
h, with b0 =λ0π, bh =
sin (hλ0)
hπh = 1, 2, ..
References
i. Baxter and King (1999) BRev. Econ. & Stat. 81, 575-593.
ii. Corbae, Ouliaris & Phillips (2002). Econometrica, 70, 1067-1109..
iii Corbae & Ouliaris (2006) Ch. 6 in Econometric theory and Practice (ed. D. Corbae,
S. Durlauf and B.Hansen) Cambridge.
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An Ideal Band Pass Filter
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Business Cycles in Post War US GDP
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Post War Cycles in US GDP and Prices
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C. Difference Filtering, Unit Root Determination, Quasi-Differencing
∆Xt, ∆2Xt, ∆mXt, (1¡ L)d Xt, (1¡ θnL)Xt, θn = 1 +c
kn
References
i. Box, G. E. P. and G. M. Jenkins (1976). Time Series Analysis: Forecasting and
Control. Holden Day.
ii. Dickey D. and W. Fuller 1979, Journal of the American Statistical Association 74,
427—431.
iii. Dickey D. and W. Fuller 1981, Econometrica 49, 1057—1072.
iv. Phillips, P. C . B. (1987). Econometrica, 55, 277—302.
v. Phillips P. C. B. and W. Ploberger (1996) Econometrica, 64, 381-413.
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2. Trend Extraction by Regression
Most Common Case of Time Polynomial Regression
Xt = β0 + β1t + ... + βptp + ut = β0xt + ut, say (1)
γh = E (utut+h) ,1X
h=¡1jγhj < 1
² Efficient time series regression is possible by least squares (OLS)
² Grenander Rosenblatt Theorem
— OLS regression on (1) is asymptotically as efficient as GLS regression provided
spectrum fu (λ) is continuous and nonzero at λ = 0.
— Condition holds ifP1
h=¡1 jγhj < 1, andP1
h=¡1 γh 6= 0
² Asymptotic variance formula is
ω2 (X 0X)¡1
, ω2 =1X
h=¡1γh = lrvar (ut) (2)
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Notes on Application of Grenander Rosenblatt Theorem
² Formula (2) for the asymptotic variance matrix holds in spite of the asymptotic
singularity of X 0X.
² The long run variance ω2 can be estimated by the usual HAC estimator involving
lag kernel methods, e.g.
ω2 =MX
h=¡Mk
µh
M
¶γh,
1
M+M
n! 0, k (¢) = lag kernel (e.g. k (x) = 1¡ jxj )
² Efficiency result extends to the case where xt has a unit root and is strictly exoge-
nous.
² Result fails when ut has a root near unity or displays long memory. In these cases,
fu (λ) is not continuous at the origin. Efficient estimation then involves dealing with
the peak in the spectrum of fu (λ) .
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References on Trend Extraction by Regression
i. Grenander, U. and M. Rosenblatt (1957). Statistical Analysis of Stationary Time
Series. Wiley
ii. Phillips, P. C. B. and J. Y. Park (1988), Journal of the American Economic Associ-
ation 83, 111—115.
iii. Phillips, P.C.B. And C.C. Lee, (1996), In P.M. Robinson and M. Rosenblatt (eds.),
Athens Conference on Applied Probability and Time Series: Essays in Memory of
E.J. Hannan, Springer—Verlag: New York.
iv. Canjels, N. And M. Watson (1997). Review of Economics and Statistics, 79, 184-
200.
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Relative Asymptotic Efficiency of OLS vs Quasi-Differencing + OLS in Deterministic
Trend Regression
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3. Nonparametric Trend Extraction
² Sieve estimation, e.g. by polynomial regression approximation, spline
smoothers such as
argminf
(1
n
nXt=1
µXt ¡ f
µt
n
¶¶2+ λ
Z(f 00)
2
)² Kernel regression
Xt = f
µt
n
¶+ ut
f (x) =n¡1Pn
t=1XtKh
¡tn ¡ x
¢n¡1Pn
t=1Kh
¡tn ¡ x
¢ = argminf
nXt=1
(Xt ¡ f)2Kh
µt
n¡ x
¶Kh (z) = h¡1K
³zh
´, K (¢) = kernel function (e.g.
1p2π
e¡z2/2), h = bandwidth
² Local linear trend regression
argminf0,f1
nXt=1
µXt ¡ f0 ¡ f1
µt
n¡ x
¶¶2Kh
µt
n¡ x
¶
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Asymptotics and Inference
² For kernel regression under regularity conditions and undersmoothingpnh
³f (x)¡ f (x)
´» N
µ0, σ2u
ZK (s)2 ds
¶²When ut is autocorrelated, such NP estimates are not asymptotically efficient - un-
like parametric regression estimates. Refined procedures (like NP Cochrane-Orcutt
transformations) help to improve efficiency and reduce the variance component σ2u
to σ2ε where ut = C (L) εt.
References on NP Regression + Efficiency
i. Xiao, Z. et. al. (2003) J. American Statistical Association, 98, 980-992.
ii. Su, L. and A. Ullah (2005) More efficient estimation in nonparametric regression
with nonparametric autocorrelated errors. Mimeo.
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Asymptotic Variance involves the following limit for x 2 (0, 1)
n¡1nXt=1
Kh
µt
n¡ x
¶=1
n
nXt=1
1p2πh
e¡(
tn¡x)
2
2h2 »Z 1
0
1p2πh
e¡(s¡x)2
2h2 ds
=
Z (1¡x)h
¡xh
1p2π
e¡12z
2dz !
Z 1
¡1
1p2π
e¡12z
2dz = 1
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Model Choice, Order Determination andAutomated Econometric Inference
² Model selection approaches - Bayesian, Information theoretic, Prequential, Likeli-
hood inference
² Applications to: trend, order selection, differencing + unit roots, cointegration rank,
parameter restrictions, Bayesian hyperparameters
² Automation in inference and prediction
² Nonparametric bandwidth selection, sieve order selection
² Data snooping
² Proximity theorems - how close can we get to the true model?
² Post Model Selection Inference
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References
i. Schwarz, 1978. Annals of Statistics 6, 461—464.
ii. Vuong, Q. (1989). Econometrica, 57, 307-333.
iii. Phillips P. C. B. and W. Ploberger (1996) Econometrica, 64, 381-413.
iv. Phillips, P. C . B. (1996). Econometrica, 64, 763-812.
v.White, H. (2000). Econometrica, 68, 1097-1126.
vi. Ploberger, W. and P. C. B. Phillips (2003). Econometrica, 71, 627-673.
vii. Leeb, H. and B. M. Potscher (2005). Econometric Theory, 21, 21-59.
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Model Selection - the Bayesian Approach
Assign prior probabilities to models and set up likelihoods and priors for individual
models to explain data Xn:
Models : Mj : j = 1, ..., J
Prior Probabilities : πj : j = 1, ..., J
Joint Probability: P (Mj,Xn) = P (Mj)P (X
njMj))
= P (Xn)P (MjjXn)
Posterior Probability of Model:P (MjjXn) =P (Mj)P (X
njMj)
P (Xn)
=πjP (X
njMj)PJk=1 πkP (X
njMk)
Data Probability P (Xn) =JX
k=1
πkP (XnjMk)
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Selection Rule
² Choose model according to the rule that maximizes posterior probability of the
model using P (MjjXn) =P(Mj)P(XnjMj)
P (Xn)
j = argmaxj
P (MjjXn) = argmaxj
pdf (XnjMj)
if prior probability πj =1
jis uniform across models
² Requires evaluation of P (XnjMj) or Bayes data density pdf (XnjMj)
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Bayes Data Density
² Use Bayes Rule to extract data probability P (XnjMj) for model Mj
P (XnjMj) =
ZΘj
Θj = parameter space
for model Mj
πMj(θj)
prior density
for θj
pdfMj(Xnjθj)
likelihood
for θj
dθj
parameter
for model Mj
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Asymptotic Form of Data Density
² Let n (θ) = log (pdf (Xnjθ)) be log likelihood. Then, under some general regularity
conditions θ
pdf (Xn) =
ZΘ
π (θ) pdf (Xnjθ) dθ =ZΘ
π (θ) e n(θ)dθ
»(2π)k/2 π
³θ´e n(θ)¯
In
³θ´¯1/2 PIC density, with
8><>: θ =MLE of θ
In
³θ´= information
² Log data density
log (pdf (Xn)) » n
³θ´
log likelihood
¡ 1
2log
¯In
³θ´¯
penalty involving
sample information
+ Oa.s. (1)
prior density is
of smaller order
= penalized log likelihood
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General Model Choice Rule — PIC Criterion:
j = argmaxj
pdf (XnjMj)
= argmaxj
½Mjn
³θj
´¡ 12log
¯IMjn
³θj
´¯¾
Stationary Case — BIC Order Criterion:
Sample information satisfies
1
nIn
³θ´= ¡1
n
∂2 n
³θ´
∂θ∂θ0!a.s. I (θ) = limiting Fisher information
so that the penalty term in the penalized likelihood
1
2log
¯In
³θ´¯
» 1
2log fnI (θ)g = 1
2log
¡nk¢+1
2log jI (θ)j » k
2log (n)
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has the simple form
1
2£ Parameter Count £ log n
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Automated Discovery & Econometric InferenceLimitations of Practical Modeling
Proposition:
Models are not only unknown but inherently unknowable.
E. J. Hannan:
“Never any attainable true system generating the data.”
Best to be hoped for –
“Such understanding of structure of system to be available that only a
VERY RESTRICTED model class can be successfully used.”
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Proximity TheoryHow close to true system can we come?
² Quantify closeness: KL distance, relying on
log
µdGdPθn
n
¶ Ã candidate data measure
à parametric measure
9=; = relative likelihood
² Bounds?: when parameters (θn) have to be estimated there is a bound on how
close we can get to Pθnn
² Factors: bound depend on
– dimension of parameter space (curve of dimensionality)
– “information” in data
² References:
–Rissanen (1986, 1987); Ploberger & Phillips (1996,2003; Econometrica)
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— Probability Framework —
² space: (Ω,F , P ), Fn, Pn = P jFn
² data: Y n = (Yt)n1
² parameterized family: Pθn , θ 2 Θ
θ0n = argmaxθ
Zln
µdPθ
n
dPn
¶dPn
= argminKL(Pn, Pθn)
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— Popular Model Classes —
² VARs + trends: Var(p) + Tr(t)
yt = J(L)yt¡1 + d(t) + εt
² Dynamic SEMs & Structural VARs
Byt = J(L)yt¡1 + d(t) + εt
² RRRs & ECMs
∆yt = αβ0yt¡1 + Φ(L)∆yt¡1 + d(t) + εt
∆yt = α0β0(b)0yt¡1 + Φ(L)∆yt¡1 + d(t) + εt
² BVAR’s
∆yt = Ayt¡1 + Φ(L)∆yt¡1 + d(t) + εt = Cxt + εt
prior: π(c) =d N(c, Vc), Vc = Vc(ψ); hyperparameters: c, Vc = diag(λ, θ)
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— Why Reduce # Parameters? —
² improve forecasting performance
% RRR’s
VAR’s ! ECM’s
& BVAR’s
² help interpret results
² curse of dimensionality (given n) can getdGM1
dPθ0>
dGM2
dPθ0for fittedM1, M2
when #M1 < #M2
even if Pθ0 has more parameters (and is closer in form toM2)!!
² small is beautiful
– small models easy to adapt; big models hard to adapt - greater commitment to
specification
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— How to Choose Models —
² Classical pretesting
– sequential tests
– general to specific
– specific to general
² Bayesian
–posterior odds: P (M1)/P (M2)
–Bayes factors: dQM1/dQM2 = pdf1(Xn)pdf2(Xn)
–predictive odds (Geisser, Atkinson, Gelfand)
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² Prequential: – sequential 1-period ahead forecast densitiesnY
t=n0+1
fM1(ytjY t¡1, θt¡1)
nYt=n0+1
fM2(ytjY t¡1, ϕt¡1)
² Information criteria: stochastic complexity minimum description length
AIC, BIC, MDL, PIC
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— Special Issues —
²Models with hyperparameters
yt = Π(c)xt + εt
–prior
c =d N(c, Vc)
c = c(ψ), Vc = Vc(ψ)
– tightness hyperparameters ψ
² No clear parameter count
# = dim(c) , Vc > 0
# = 0 , Vc = 0 (c = c0)
² continuum of choices [0,#(c)]
² non nested models – in VAR class (e.g., BVARs, RRRs)
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Simple Illustration: Spurious Regression
True DGP: yt = yt¡1 + ut
fitted model: yt = bt + ut
Limit behavior
b !p 0
t(b) divergent Op(n1/2)
Conclusion
² deterministic trend proxies for unit root
² model shortcoming NOT statistical
² trends, I(1) data = powerful regressors
² can be “powerfully wrong” in forecasting
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— Themes in Automated Modeling —
² Role of Model
– language to express regular features of data
Rissanen (1986) suggests goal is to
“remove untenable assumptions of data generation systems and ‘true’ parameters”
² Primary task
Dawid (1984)’s prequential approach
– “make sequential probability forecasts of future observations”
²Modeling evolutionary mechanisms
– data dependent
8<: parameter count
initialization
LeCam & Yang (1990): “# parameters” depends on “# observations
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— Use Model Selection —for Parsimony & Practicality
² Bayes factor (LR)
pdf 0(Xn)
pdf 1(Xn)>=<1?
H0: pdf 0(Xn) =Rπ0(θ)pdf(X
njθ)dθ
H1: pdf 1(Xn) =Rπ1(ψ)pdf (X
njψ)dψ
² asymptotic form:
log(pdfj(Xn) » jn(θ
j
n)¡ 12 log jI
jnj
² criterion: choose model Mbj according to PIC criteriabj = argmax
j
njn(θ
j
n)¡ 12 log jI
jnjo
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Application — Order Selection in Gaussianmodels
AR(k), ARMA(p, q), Tr(t)
² PIC argmaxk
log jΣnj + 1n log jInj
² BIC argmaxk
log jΣnj + kn log n
² HQ argmaxk
log jΣnj + kn log log n
² AIC argmaxk
log jΣnj + 2kn
² PIC has greater penalty for trend
PIC: log
ÃnXt=1
t2
!= log n3 + const. » 3 log n
BIC: log n
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— Compare Predictive Odds —
² Bayes predictive oddspdf 0(Xn
n0+1jXn0)
pdf 1(Xnn0+1
jXn0)>=<1 ?
pdfj(Xnn0+1
jXn0) =pdfj(Xn)
pdfj(Xn0)
² Asymptotic form: conditional PIC/PICF
log likelihood| z conditional penalty| z jn(θ
j
n) ¡ 12 log(jIjnj/jIjn0j)
² Prequential form is equivalent as n, n0 ! 1,
p0n,n0p1n,n0
=
nYt=n0+1
f 0t (¢jθ0
t¡1,Xt¡1)
nYt=n0+1
f 1t (¢jθ1
t¡1,Xt¡1)
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— VAR, RRR & BVAR Models —
²Model VAR(k, )
∆yt = Ayt¡1 +k¡1Xi=0
Φi∆yt¡1¡i +X0
cjtj + εt
= Cxt + εt, εt ´ iid(0,Σ)
²Model RRR(r, k, )
A = αβ0, β0 = [Ir, F ] say
²Model BVAR
prior π(c) ´ N(c, Vc), c = c(ψ)
hyperparameters ψ, Vc = Vc(ψ)
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² BVARM–Minnesota priors
c = 0, 1 (main diagonal)
diag (Vci) =
8><>: (λ/a)2, i = j own variable, lag = a³λθσiaσj
´2, i 6= j lag = a
² BVAR — RBC–Real business cycle model priors
– Ingram &Whiteman (1996)
– Schorfheide (2003)
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— Automated Model Choice —
² General form: — selection criterion
PIC = log jΣnj + 1n log(jInj/jIn0j)
² VAR(k, ) form
In = Σ¡1n −X 0X
² RRR
In =
24 Σ¡1n − U 0U 0
0 α0nΣ
¡1n αn − Y 0
2,¡1Y2,¡1
35 G
F
model
∆yt = αβ0yt¡1 + Φzt + εt
= Gut + εtstationary
β0yt¡1 = y1t¡1 + Fy2t¡1 nonstationary
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— BVAR Forms —
² BVAR
prior π(c) ´ N(c, Vc)
Vc = Vc(ψ)
information In,m = V ¡1cprior
+ Σ¡1n −X 0Xsample
² BVARM case
Vc = Vc(λ, θ), λ, θ tightness parameters
² limits for tightness
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– λ ! 0 model: ∆yt = c0ddt + εt only trend left
jInmj/In0m !nY
n0+1
(1 + d0s(D0s¡1Ds¡1)
¡1ds
= jInj/jIn0j
– λ ! 1 forecast error variance for model
jInj/jIn0j ! jInj/jIn0j for unrestricted VAR
get continuum of models + penalties
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— Optimized BVAR’s —
² (λ, θ) = argminλ,θ
PICBVARM(λ,θ)
² optimal data determined values of hyperparameters
² makes use of BVAR’s automatic
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— Optimized RRR’s —
² Rule: (r, k, ) = argminr,k,
P ICRRR(r,k, )
∆yt = Ayt¡1 +k¡1X0
Φi∆yt¡1¡i +X0
cjtj + εt
A = αβ0m£r r£m
² Consistent estimation of cointegrating rank (Chao & Phillips, 1999: JOE)
r ! pr
k ! pk
ˆ ! p
in conjunction with lag order and trend order selection
² Combine with MLE: estimate cointegrating space + adjustment/factor loadings
α, β
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² Compare the Classical Likelihood Ratio (LR) approach to testing
(Johansen, 1996)
– not consistent unless size! 0
–vulnerable to initial settings of lag length and trend degree and inclusion of
intercept
– sequential testing procedures problematic - multiple routings
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— Data Discarding and Lifetime of a Model —
² specify a recent history [na, nb] for calibration
² Permit range of initializations τ 2 [n0, n0]
– n0 = minimal information time
– n0 = latest possible initialization
² Data-determined τ :
τ = argmaxτ2[n0,n0]
qnb(¢jFnaτ )
qnb(¢jFnan0 )
i.e.,
τ = maxτ
·qnb(¢jF
naτ ) =
dQnb
dPnb
¯Fnaτ
¸maximize conditional Bayes data density [na + 1, nb] given Fna
τ
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—Optimality Issues —Can we do better in modelling the ‘dgp’?
(Ploberger and Phillips, 1999,2003)
² Rissanen (1986, 1987): θ 2 Θk a.e.
lim infn
Eθflog[f(Y n; k, θ)/g(Y n)]g(k/2) log(n)
¸ 1
i.e.
– closest KL distance we can come on average to true density f is bounded below
by “(k/2) log(n)” as n ! 1
except for
– negligible sets of θ (λf...g = 0) –λ = Lebesgue measure
² Proof using pn cgce, CLT for θn
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— Extension to Cases of Random Information —
² for compact set K ½ Θ
λ
½θ 2 K : Pθ
n
·¡ log dG
dPθn
· 1
2(1¡ ε) log jBnj
¸¸ α
¾! 0
ε, α > 0 as n ! 1, Bn = qv score » In
² measure closeness to Pθn by ¡ log(dG/dP θ
n)
² you can’t come closer to Pθn than
12(1¡ ε) log jBnj with the probability as n ! 1
Except for negligible sets with λ(...) = 0
² divine providence (know θ or parts of it)
² great guess
² prior information that reduces dim(Θ)
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— Proximity of Bayes model & dgp —
²
log
µdQn
dPθn
¶= log c + 1
2V0nB
¡1n Vnq
Op(1)
+ 12 log jBnj under Pθ
n
» ¡12 log jBnj as n ! 1
comes arbitrarily close (up to ε > 0) to lower bound of approximation
² Cannot do better than Qn (or QnjFn0 if π improper) except on negligible θ-sets as
n ! 1
² justifies Bayes Qn and classical predictive
Pn = Πnn0ff(¢; θt¡1)
in sense that for an arbitrary empirical measure Gn we have
log
µdGn
dP θn
¶¸essentially log
µdQn
dPθn
¶» 1
2log jBnj
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— Example —
² Gaussian linear model
yt = x0tθ + ut ut ´ iid N¡0, σ2
¢² Concentrated log likelihood & information
n(θ) = ¡12
X(yt ¡ x0tθ)
2, Bn =Xt·n
xtx0t
² Trend & stochastic regressor case
x0t = (1, t,W1, ...,Wm,Z1, ..., Zp) , Wt ´ I (1) , Zt ´ I (0)
² Asymptotic information content of data
log detBn
2(12 +32 +m + p
2) log n! 1
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— Implications —
² deterministic linear trend ‘costs’ (in terms of the distance between the empirical
model and the DGP) three times as much as the lack of knowledge about the con-
stant or the coefficient of a stationary variables!
² stochastic trend costs twice as much!
² higher order trends costs more.
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— Prediction —
² Optimal Predictor & arbitrary predictor
byt = E (ytjFt¡1) = x0tθ0, yt = yt(xt, zt¡1)
² Associated empirical model G — from probability densityYt·n
q(ytjxt, zt¡1)
qt(ytjxt, zt¡1) =1p2πσ2
exp
µ¡(yt ¡ yt)
2
2σ2
¶² Likelihood ratio of two models
¡ log dGdPθ
=1
2σ2
Xt·n
f(yt ¡ yt)2 ¡ (yt ¡ x0tθ0)
2g = ∆n
² Ploberger - Phillips bounds
∆n ¸essentially1
2log detBn
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— Implications for Prediction —
² MSE of forecast boundsPt·n(yt ¡ yt)
2 ¸essentiallyP
t·n(yt ¡ x0tθ0)2 + σ2
2 log jBnj...
MSE (yt)
...
MSE (byt)–bound measures how close MSE is to that of optimal predictor!
– effect of trends on optimal prediction same as on dgp!
– distance depends on fitted model!
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— Simulations —
² Gaussian linear model
yt = x0tθ + ut ut ´ iid N (0, 1)
² Regressors - stationary, unit root and deterministic trends
xt ´ AR (1, ρ = 0.5) , RW, t, t2, t3
² Forecast Divergence
∆n =Xt·n
f(yt ¡ yt)2 ¡
Xt·n(yt ¡ x0tθ0)
2
² Compute pdf (∆n) , P f∆n > (1¡ ε)K log ng for n = 10, ..., 100 and ε = 0.05
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Probability Densities of Forecast Differential
∆n =Xt·n(yt ¡ yt)
0Ω¡1 (yt ¡ yt)¡Xt·n(yt ¡ yt)
0Ω¡1 (yt ¡ yt)
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Probability densities of ∆nK logn
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Simulation Estimates of P f∆n ¸ (1¡ ε) log ng116
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— Automated Model Discovery —Quo Vadis
² General Approach
–data-based model determination - allows the data to choose
–models evolve over time; PIC’ed by predictive odds criterion
– has Bayesian, classical, prequential justifications
– lag length, cointegrating rank, time trends, unit roots all determined automati-
cally & adjusted period by period
– order estimates all consistent, including cointegrating rank
– can use in conventional time series tests, e.g. for causal effects
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² Methodology
– closer in philosophy to Rissanen (1986, 1987), West and Harrison (1986) &Dawid
(1984) than to some common econometric methodologies
– yields optimised BVAR(bψ) and RRR(br,bk,bl) models– finds ‘Bayes model’ model that is ‘closest’ to the true dgp and forecasts that are
closest to optimal forecasts
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² Practical Experience
– ex post forecasting analyses in Phillips (1993, 1995, J. Econometrics) for US data
and with Nelson & Plosser data;
– ex ante forecasting experience in Asia Pacific Economic Review (1995-1999) for
USA, Japan, Korea, Australia and New Zealand
– comparisons with Fair Model on real GDP growth and inflation
– application to New Zealand with built-in policy analysis (effects of monetary
policy changes and recession in US) Schiff & Phillips (1999, NZEP)
–Web-based applications in NewZealand on Predicta website: http://covec.co.nz/
² A New Research Goal: An Interactive Econometric Web Server
— real time econometric data & policy analysis to inform public economic debate
— point, click, select series for modeling and forecasting & upload data for analysis.
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