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Stationary Stochastic Process: 1 M t1 TM t1+h TM+H T

This document discusses different types of stochastic processes including stationary, covariance stationary, weakly dependent, MA(1), AR(1), trend-stationary, and random walk processes. It explains that a stationary process has a constant joint distribution across time lags, while a covariance stationary process only requires a constant mean and variance. A weakly dependent process has correlations that decrease to zero as the time lag increases. An MA(1) process depends on the current and previous shock, while an AR(1) process depends on the previous period's value. A random walk process is highly persistent and not weakly dependent. The document also discusses assumptions needed for consistency in regression models and transforming persistent series.

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159 views11 pages

Stationary Stochastic Process: 1 M t1 TM t1+h TM+H T

This document discusses different types of stochastic processes including stationary, covariance stationary, weakly dependent, MA(1), AR(1), trend-stationary, and random walk processes. It explains that a stationary process has a constant joint distribution across time lags, while a covariance stationary process only requires a constant mean and variance. A weakly dependent process has correlations that decrease to zero as the time lag increases. An MA(1) process depends on the current and previous shock, while an AR(1) process depends on the previous period's value. A random walk process is highly persistent and not weakly dependent. The document also discusses assumptions needed for consistency in regression models and transforming persistent series.

Uploaded by

Souhail
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Stationary Stochastic Process

A stochastic process is stationary if for


every collection of time indices 1 ≤ t1 < …<
tm the joint distribution of (xt1, …, xtm) is the
same as that of (xt1+h, … xtm+h) for h ≥ 1
Thus, stationarity implies that the xt’s are
identically distributed and that the nature of
any correlation between adjacent terms is the
same across all periods
Economics 20 - Prof. Anderson 1
Covariance Stationary Process
A stochastic process is covariance
stationary if E(xt) is constant, Var(xt) is
constant and for any t, h ≥ 1, Cov(xt, xt+h)
depends only on h and not on t
Thus, this weaker form of stationarity
requires only that the mean and variance are
constant across time, and the covariance just
depends on the distance across time
Economics 20 - Prof. Anderson 2
Weakly Dependent Time Series
A stationary time series is weakly
dependent if xt and xt+h are “almost
independent” as h increases
If for a covariance stationary process
Corr(xt, xt+h) → 0 as h → ∞, we’ll say this
covariance stationary process is weakly
dependent
Want to still use law of large numbers

Economics 20 - Prof. Anderson 3


An MA(1) Process
A moving average process of order one
[MA(1)] can be characterized as one where
xt = et + 1et-1, t = 1, 2, … with et being an
iid sequence with mean 0 and variance 2e
This is a stationary, weakly dependent
sequence as variables 1 period apart are
correlated, but 2 periods apart they are not

Economics 20 - Prof. Anderson 4


An AR(1) Process
An autoregressive process of order one
[AR(1)] can be characterized as one where
yt = yt-1 + et , t = 1, 2,… with et being an
iid sequence with mean 0 and variance e2
For this process to be weakly dependent, it
must be the case that || < 1
Corr(yt ,yt+h) = Cov(yt ,yt+h)/(yy) = 1h
which becomes small as h increases

Economics 20 - Prof. Anderson 5


Trends Revisited
A trending series cannot be stationary,
since the mean is changing over time
A trending series can be weakly dependent
If a series is weakly dependent and is
stationary about its trend, we will call it a
trend-stationary process
As long as a trend is included, all is well

Economics 20 - Prof. Anderson 6


Assumptions for Consistency
Linearity and Weak Dependence
A weaker zero conditional mean
assumption: E(ut|xt) = 0, for each t
No Perfect Collinearity
Thus, for asymptotic unbiasedness
(consistency), we can weaken the
exogeneity assumptions somewhat relative
to those for unbiasedness

Economics 20 - Prof. Anderson 7


Large-Sample Inference
Weaker assumption of homoskedasticity:
Var (ut|xt) = 2, for each t
Weaker assumption of no serial correlation:
E(utus| xt, xs) = 0 for t  s
With these assumptions, we have
asymptotic normality and the usual standard
errors, t statistics, F statistics and LM
statistics are valid

Economics 20 - Prof. Anderson 8


Random Walks
A random walk is an AR(1) model where
1 = 1, meaning the series is not weakly
dependent
With a random walk, the expected value of
yt is always y0 – it doesn’t depend on t
Var(yt) = e2t, so it increases with t
We say a random walk is highly persistent
since E(yt+h|yt) = yt for all h ≥ 1

Economics 20 - Prof. Anderson 9


Random Walks (continued)
A random walk is a special case of what’s
known as a unit root process
Note that trending and persistence are
different things – a series can be trending
but weakly dependent, or a series can be
highly persistent without any trend
A random walk with drift is an example of
a highly persistent series that is trending

Economics 20 - Prof. Anderson 10


Transforming Persistent Series
In order to use a highly persistent series
and get meaningful estimates and make
correct inferences, we want to transform it
into a weakly dependent process
We refer to a weakly dependent process as
being integrated of order zero, [I(0)]
A random walk is integrated of order one,
[I(1)], meaning a first difference will be I(0)

Economics 20 - Prof. Anderson 11

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