Introduction to Econometrics (3rd Updated Edition)

by

James H. Stock and Mark W. Watson

Solutions to Odd-Numbered End-of-Chapter Exercises:

Chapter 16

(This version July 20, 2014)

©2015 Pearson Education, Inc. Publishing as Addison Wesley

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 16 1
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16.1. Yt follows a stationary AR(1) model, Yt  0  1Yt 1  ut . The mean of Yt is

0
Y  E (Yt )  , and E(ut |Yt )  0.
1  1

(a) The h-period ahead forecast of Yt , Yt  h|t  E (Yt  h | Yt , Yt 1 ,), is

Yt  h|t  E (Yt  h |Yt , Yt 1 ,)  E (  0  1Yt  h 1  ut |Yt , Yt 1 ,)

  0  1Yt  h 1|t   0  1 (  0  1Yt  h  2|t )
 (1  1 )  0  12Yt  h  2|t
 (1  1 )  0  12 (  0  1Yt  h 3|t )
 (1  1  12 )  0  13Yt  h 3|t
 
 1  1    1h 1   0  1hYt
1  1h
  0  1hYt
1  1
 Y  1h (Yt  Y ).

(b) Substituting the result from part (a) into Xt gives

 
X t    iYt i|t    i [ Y  1i (Yt  Y )]
i 0 i 0
 
 Y   i  (Yt  Y ) ( 1 )i
i 0 i 0

Y Yt  Y
  .
1   1  1

©2015 Pearson Education, Inc. Publishing as Addison Wesley

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 16 2
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16.3. ut follows the ARCH process with mean E (ut)  0 and variance  t2  1.0  0.5ut21.

(a) For the specified ARCH process, ut has the conditional mean E (ut |ut 1 )  0 and
the conditional variance.

var (ut | ut 1 )   t2  1.0  0.5ut21.

The unconditional mean of ut is E (ut)  0, and the unconditional variance of ut is

var (ut )  var[ E (ut | ut 1 )]  E[var (ut | ut 1 )]

 0  1.0  0.5 E (ut21 )
 1.0  0.5 var (ut 1 ).

The last equation has used the fact that E (ut2 )  var(ut )  E (ut )]2  var(ut ),
which follows because E (ut)  0. Because of the stationarity, var(ut–1)  var(ut).
Thus, var(ut)  1.0  0.5var(ut) which implies var(ut )  1.0
0.5  2.

(b) When ut 1  0.2,  t2  1.0  0.5  0.22  1.02. The standard deviation of ut is t 
1.01. Thus

 3 ut 3 
Pr (3  ut  3)  Pr    
 1.01  t 1.01 
  (2.9703)   ( 2.9703)  0.9985  0.0015  0.9970.

When ut–1  2.0,  t2  1.0  0.5  2.02  3.0. The standard deviation of ut is t 
1.732. Thus

 3 u 3 
Pr (3  ut  3)  Pr   t  
 1.732  t 1.732 
  (1.732)   (1.732)  0.9584  0.0416  0.9168.

©2015 Pearson Education, Inc. Publishing as Addison Wesley

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 16 3
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16.5. Because Yt  Yt  Yt 1  Yt 1  Yt 1  Yt ,

T T T T T

Yt 2  (Yt 1  Yt )2  Yt 21   (Yt )2  2Yt 1Yt .

t 1 t 1 t 1 t 1 t 1

So

1 T 1 1 T 2 T 2 T 

T t 1
Yt 1Yt    Yt   Yt 1   (Yt )2  .
T 2  t 1 t 1 t 1 

Note that Tt 1 Yt 2  Tt 1 Yt 21   Tt 11 Yt 2  YT2   Y02  Tt 11 Yt 2   YT2  Y02  YT2 because
Y0  0. Thus:

1 T 1 1 2 T 

T t 1
Yt 1 Yt   YT   (Yt )2 
T 2 t 1 
1  YT  1 T 
2

     (Yt )2  .
2  T  T t 1 

©2015 Pearson Education, Inc. Publishing as Addison Wesley

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 16 4
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16.7.

1 T
 Tt1 Yt X t  Tt1 Yt Yt1  Y Y
̂  T 2  T  T t1 t t1 .
 t1 X t  t1 (Yt1 )2 1 T
 t1 (Yt1 )2
T

Following the hint, the numerator is the same expression as (16.21) (shifted forward
 u2
in time 1 period), so that 1
T Tt 1 Yt Yt 1 
d
2 ( 12  1). The denominator is

Tt 1 (Yt 1 ) 2  T1 Tt 1 ut21   u2 by the law of large numbers. The result follows
1 p
T

directly.

©2015 Pearson Education, Inc. Publishing as Addison Wesley

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 16 5
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16.9. (a) From the law of iterated expectations

E (ut2 )  E  t2 
 E  0  1ut21 
  0  1 E  ut21 
  0  1 E  ut2 

where the last line uses stationarity of u. Solving for E (ut2 ) gives the required
result.

(b) As in (a)

E (ut2 )  E  t2 
 E  0  1ut21   2ut2 2     p ut2 p 
  0  1 E  ut21    2 E  ut2 2      p E  ut2 p 
  0  1 E  ut2    2 E  ut2      p E  ut2 

0
so that E (ut2 ) 
1  tp1 i

(c) This follows from (b) and the restriction that E (ut2 ) > 0.

(d) As in (a)

E (ut2 )  E  t2 
  0  1 E  ut21   1 E  t21 
  0  (1  1 ) E  ut21 
  0  (1  1 ) E  ut2 
0

1  1  1

(e) This follows from (d) and the restriction that E  ut2   0.

©2015 Pearson Education, Inc. Publishing as Addison Wesley