PROBLEMSET4–SOLUTIONS-DiscoverEconomics.docVIP

Problem Set 4 – Solutions Part I – Analytical Questions Problem 1: Consider a stationary autoregressive process A(L)Xt = (t and its corresponding moving average representation, Xt = C(L)(t , where . Find the moving average coefficients for an VAR(1) process. Solution Because this is a VAR(1), calculation of the MA representation is quite easy. Thus, if Xt = A1Xt-1 + (t, then Ci = A1i. Show that the moving average coefficients for a VAR(2) can be found recursively by Solution A stationary VAR has a moving average representation given by . Plugging this formula into that of a VAR(2) such as, , we find, , which can be rewritten as, , which delivers the coefficients for each of the epsilon. Since the epsilon can take on any value in , each of these coefficients must equal zero. Hence, C0 = I, C1 = A1, and Problem 2: Consider the following bivariate VAR, with . Find a matrix H, which is lower triangular and ensures that if , then where D is a diagonal matrix. Solution For example, Given this matrix H calculate the structural representation of this VAR. Solution Calculate the VMA representation for the reduced form of this VAR (notice that it is very simple in this case – don’t apply the usual formulas mechanically!) Solution  Calculate the VMA representation of the structural form of the VAR. Solution Under what conditions will the reduced form and the structural form produce identical impulse response functions? Solution: The obvious one is ( = 0. Less obvious, Suppose you obtained the structural form as in part (a) but for a system that had the variable m ordered first. Under what conditions would these two structural identification schemes deliver the same impulse responses? Solution: Notice that the matrix H is in this case, Naturally, ( = 0, would work, but also, either or Problem 3: Consider the following bivariate VAR with for t = ( and 0 other wise, for t = ( and 0 other wise, a