2.6 Time Series

2.6 Time Series

Question 1

For a certain time series, you have produced a correlogram with an autocorrelation function that includes twenty four monthly observations; $m=\text{degreesoffreedom}=24$. Your calculated Box-Pierce Q-statistic is $19.50$ and your calculated Ljung-Box Q-statistic is $27.90$. You want to determine if the series is white noise. Which is your best conclusion(given $\text{CHISQ.INV}(0.95,24)=36.41$)?

A. With $95.0\%$ confidence, you accept the series as white noise (more accurately, you fail to reject the null)
B. With $95.0\%$ confidence, you accept the series as partial white noise (due to Box-Pierce) but reject the null (due to Ljung-Box)
C. With $95.0\%$ confidence, you reject both null hypotheses and conclude the series is not white noise
D. With $95.0\%$ confidence, you reject both null hypotheses but conclude the series is white noise because the sum of the statistics is greater than the critical value

Answer: A
Testing autocorrelation in the residuals is a standard specification check applied after fitting a model.
Null hypothesis: All its autocorrelations are jointly 0. (i.e., $H_0:{\rho }_1={\rho }_2=\cdots ={\rho }_h$).
Alternative hypothesis: At least one is non-zero. (i.e., $H_1:{\rho }_j\ne 0$ for some $j$).

The Box-Pierce test statistic is scaled by the sample size $T$, $Q_{BP}=T{\sum }_{i=1}^h{\widehat{{\rho }_i}}^2\sim {\chi }_h^2$
The Liung-Pierce test statistic works better in smaller samples, $Q_{LP}=T{\sum }_{i=1}^h(\frac{T+2}{T-i}){\widehat{{\rho }_i}}^2\sim {\chi }_h^2$

Values of the test statistic larger than the critical value indicate that the autocorrelations are not zero.

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Question 2

All of the following traits characterize the covariance stationary of a time series process, except:

A. Stability of the mean.
B. Stability of the covariance structure.
C. A non-constant variance in the time series.
D. Stability of the autocorrelation

Answer: C
A time series is covariance stationary if its first two moments satisfy three key properties:

• The mean is constant and does not change over time.(i.e., $E[Y_t]=\mu$ for all $t$)
• The variance is finite and does not change over time.(i.e., $V[Y_t]={\gamma }_0<\infty$)
• The autocovariance is finite, does not change over time, and only depends on the distance between observations($h$).(i.e., $Cov[Y_t,Y_{t-h}]={\gamma }_h$ for all $t$)

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Question 3

The following are statements about a moving average($\text{MA}$) representation, and an autoregressive($\text{AR}$) process. Which one describes the main difference between $\text{MA}$ representation and $\text{AR}$ process.

A. Moving average ($\text{MA}$) representation shows an evidence of autocorrelation cutoff.
B. The autoregressive ($\text{AR}$) process will never be covariance stationary.
C. The autoregressive ($\text{AR}$) process shows evidence of autocorrelation cutoff.
D. An unadjusted moving average ($\text{MA}$) process shows a clear evidence of a gradual autocorrelation decay.

Answer: A
Autocorrelation function(ACF): $\frac{{\gamma }_h}{{\gamma }_0}$, refers to the degree of correlation and interdependency between data points in a time series.

Autoregressive($\text{AR}$) model is defined as the current value of a series is linearly related to its past values, plus an additive stochastic shock.
A first order $\text{AR}$ can be denoted $\text{AR}(1)$, $Y_t=\delta +\varphi Y_{t-1}+{ϵ}_t$, where ${ϵ}_t\sim WN(0,{\sigma }^2)$

• $\text{AR}(1)$ is covariance stationary when $|\varphi |<1$.
• Expectation: $E[Y_t]=E[Y_{t-h}]=\mu =\frac{\delta }{1-\varphi }$
• Variance: $V[Y_t]=V[Y_{t-h}]={\gamma }_0=\frac{{\sigma }^2}{1-{\varphi }^2}$
• Autocovariance: $Cov[Y_t,Y_{th}]=\gamma (h)={\varphi }^{|h|}{\gamma }_0$
• Autocorrelation(ACF): $\rho (h)={\varphi }^{|h|}$, the ACF geometrically decays to zero as $h$ increases, it also oscillates between negative and positive if $-1<\varphi <0$
• Partial autocorrelation(PACF): α ( h ) = ϕ ∣ h ∣ ,    h ∈ { 0 , ± 1 } \alpha(h)=\phi^{|h|},\;h\in \lbrace0,\pm1\rbrace α(h)=ϕ∣h∣,h∈{0,±1}, $\alpha (h)=0,h\ge 2$, the PACF is non-zero only for the first lag.

The moving average ($\text{MA}$) model is defined as the observed value of $Y_t$ depends on both the contemporaneous shock ${ϵ}_t$ and the previous shock.
A first order $\text{MA}$ can be denoted $\text{MA}(1)$, $Y_t=\mu +\theta {ϵ}_{t-1}+{ϵ}_t$, where ${ϵ}_t\sim WN(0,{\sigma }^2)$

• $\text{MA}$ is always covariance stationary.
• Expectation: $E[Y_t]=E[Y_{t-h}]=\mu$
• Variance: $V[Y_t]=V[Y_{t-h}]={\gamma }_0=(1+{\theta }^2){\sigma }^2$
• Autocovariance: $Cov[Y_t,Y_{th}]=\gamma (h)=0$, for $h>1$
• Autocorrelation: $\rho (h)=1$, when $h=0$, $\rho (h)=0$, when $h\ge 2$, $\rho (h)=\frac{\theta }{1+{\theta }^2}$, when $h=1$
• Partial autocorrelation: The PACF has non-zero values at all lags and decays towards zero.

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Question 4

PE2018Q21 / PE2019Q21 / PE2020Q21 / PE2021Q21 / PE2022PSQ14 / PE2022Q21
A risk manager at a major global bank is conducting a time series analysis of equity returns. The manager wants to know whether the time series is covariance stationary. Which of the following statements describes one of the requirements for a time series to be covariance stationary?

A. The distribution of a time series should have a kurtosis value near $3$, ensuring no fat tails will distort stationarity.
B. The distribution of a time series should have a skewness value near $0$, so that its mean will fall in the center of the distribution.
C. The autocovariance of a covariance stationary time series depends only on displacement term, $\tau$, not on time.
D. When the autocovariance function is asymmetric with respect to displacement, $\tau$, forward looking stationarity can be achieved.

Answer: C
Learning Objective: Describe the requirements for a series to be covariance stationary.

C is correct. One requirement for a series to be covariance stationary is that its covariance structure be stable over time. If the covariance structure is stable, then the autocovariances depend only on displacement, $\tau$, not on time, $t$. Also, covariance stationarity does not place restrictions on other aspects of the distributions or the series, such as kurtosis and skewness.

A and B are incorrect. Covariance stationarity does not place restrictions on other aspects of the distributions or the series, such as kurtosis and skewness.

D is incorrect. Covariance stationarity does not depend on the symmetry of the autocovariance function.

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Question 5

PE2020Q70 / PE2021Q70 / PE2022Q70
A market risk manager would like to analyze and forecast a security performance and has obtained the historical time series for that security. The manager consults a colleague from the quantitative analytic team who provides the following Partial Autocorrelation Function ($\text{PACF}$) plot:

Based on the plot above, which of the following is the best regression approach for the security?

A. $\text{AR}(1)$
B. $\text{MA}(1)$
C. $\text{AR}(2)$
D. $\text{MA}(2)$

Answer: C
Learning Objective: Define and describe the properties of autoregressive ($\text{AR}$) processes.

The $\text{PACF}$ cuts off after the second lag. This behavior indicates an $\text{AR}(2)$ process.

	$\text{ACF}$	$\text{PACF}$
$\text{MA}(1)$ Model	Cutoff	Decay
$\text{AR(}1)$ Model	Decay	Cutoff

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Question 6

In regard to white noise, each of the following statements is true except which is false?

A. If a process is zero-mean white noise, then is must be Gaussian white noise.
B. If a process is Gaussian (aka, normal) white noise, then it must be (zero-mean) white noise.
C. If a process is Gaussian (aka, normal) white noise, then it must be independent white noise.
D. If a process is stationary, has zero mean, has constant variance and it serially uncorrelated, then the process is white noise.

Answer: A
White noise is denoted ${ϵ}_t\sim \text{WN}(0,{\sigma }^2)$

• Mean zero (i.e., $E[{ϵ}_t]=0$)
• Constant and finite variance (i.e., $V[{ϵ}_t]={\sigma }^2<\infty$)
• No autocorrelation or autocovariance (i.e., $\text{Cov}[{ϵ}_t,{ϵ}_{t-h}]=0$ for all $h\ne 0$)

Even though a white noise process is serially uncorrelated, it may not be serially independent or normally distributed.
If ${ϵ}_t$ is serially independent, then we say ${ϵ}_t$ is independent white noise.
If ${ϵ}_t$ is serially uncorrelated and normally distributed, then we say ${ϵ}_t$ is normal or Gaussian white noise.

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