Teklebirhan Alemnew (Asst.

Prof)
[email protected]
AAU, 2024
 6.1. Introduction
 Time series analysis comprises methods for analyzing
time series data in order to extract meaningful statistics
and other characteristics of the data.

 Why we learn time series analysis? b/c

1) Time series data is frequently used in practice

2) Time series data analysis poses several challenges to

econometricians and practitioners.

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Cont…

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 Cont…
 Note that almost all of the above problems arise mainly due to
non-stationarity of time series data sets.

 Therefore, our major emphasis in this chapter shall be on

discussion of

 nature and tests of Stationarity of time series, and

 the remedial measures for non-stationary data sets.

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 6.2 The Nature of Time Series Data
 An obvious characteristic of time series data which
distinguishes it from cross-sectional data is that a time series
data set comes with a temporal ordering.

 For analyzing time series data, we must recognize that the

past can affect the future, but not vice versa.

 Certainly, economic time series satisfy the intuitive

requirements for being outcomes of random variables.

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 Cont…
 For example, today

 We do not know what the trade balance of Ethiopia will be

at the end of this year.

 We do not know what the annual growth in output will be

in Ethiopia during the coming year.

 Since the outcomes of these variables are not fore known,

they should clearly be viewed as random variables.

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Table 5.1: Time series Data on some macroeconomic variables in Ethiopia
Year TB MS2 GDP EXR G
1963 0.69 629.6 9,400 2.4000 303.99
1964 0.69 658.3 9,873 2.3000 316.19
1965 1.04 808 9,892 2.1900 348.14
1966 1.15 1066.6 10,353 2.0700 368.57
1967 0.71 1139.4 11,412 2.0700 442.89
1968 0.79 1421.8 11,145 2.0700 551.99
1969 0.86 1467.9 11,916 2.0700 654.73
1970 0.84 1682.2 13,221 2.0700 752.34
1971 0.61 1848 13,890 2.0700 942.56
1972 0.65 2053.2 15,143 2.0700 993.59
1973 0.62 2377.6 16,135 2.0700 1,017.56
1974 0.47 2643.7 16,530 2.0700 1,090.74
1975 0.29 3040.5 17,498 2.0700 1,244.54
1976 0.45 3383.7 19,655 2.0700 1,506.13
1977 0.42 3849 17,865 2.0700 1,454.12
1978 0.43 4448.2 21,517 2.0700 1,524.52
1979 0.36 4808.7 22,367 2.0700 1,636.04
1980 0.34 5238.7 23,679 2.0700 1,726.70

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 Cont…
 A sequence of random variables indexed by time is called a
stochastic process or a time series process. (“Stochastic” is a
synonym for random).

 A random or stochastic process is a collection of random

variables ordered in time.

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 6.3. Trends and Seasonality
Trend component of time series:
 A trend exists when there is a long-term increase or decrease
value in the series (data).

 It does not have to be linear.

 We have two time series trends:

a) If the trend in a time series is completely predictable and

not variable, we call it a deterministic trend,

b) whereas if it is not predictable, we call it a stochastic trend.

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 Cont…
 In a nutshell, a deterministic trend is a nonrandom function
of time whereas a stochastic trend is random and varies over
time.

 The simplest model of a variable with a stochastic trend is the

random walk.

 According to Stock and Watson (2007), it is more appropriate

to model economic time series as having stochastic rather
than deterministic trends.

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 Cont…
 Therefore, our treatment of trends in economic time series
focuses mainly on stochastic rather than deterministic trends,
and when we refer to “trends” in time series data, we mean
stochastic trends.

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 Cont…
 Seasonality component of time series :
 A seasonal pattern occurs when a time series is affected by
seasonal factors such as the time of the year or the day of the
week.

 Seasonality is always of a fixed and known frequency.

 Thus, seasonality is the repeating patterns of behavior over

time.

 However, a cycle occurs when the data exhibit rises and falls
that are not of a fixed frequency.
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Cont…

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 6.4. Stationary and Non-stationary
Stochastic Processes
 A type of stochastic process that has received a great deal of
attention by time series analysts is the so-called stationary
stochastic process.

 In colloquial language, stationarity means that the

probabilistic character of the series must not change over
time,

 A stochastic process is said to be stationary if its mean and

variance are constant over time

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Cont…

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 Cont…
 In short, if a time series is stationary, its mean, variance, and
auto-covariance (at various lags) remain the same no matter at
what point we measure them; that is, they are time invariant.

 If a time series is not stationary, its will have a time varying

mean or a time-varying variance or both.

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 Cont…
 Why are stationary time series so important? b/c

a) for the purpose of forecasting or policy analysis, such (non-

stationary) time series may be of little practical value.

b) If we have two or more non-stationary time series,

regression analysis involving such time series may lead to
the phenomenon of spurious or non-sense regression.

 How do we know that a particular time series is stationary?

 In particular, are the time series figures shown below

stationary?

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 Examples
G GDP
60,000 600,000

50,000 500,000

40,000 400,000

30,000 300,000

20,000 200,000

10,000
100,000

0
0
1965 1970 1975 1980 1985 1990 1995 2000
1965 1970 1975 1980 1985 1990 1995 2000

TB MS2

1.2 160,000

140,000
1.0
120,000

0.8 100,000

0.6 80,000

60,000
0.4
40,000

0.2 20,000

0.0 0
1965 1970 1975 1980 1985 1990 1995 2000 1965 1970 1975 1980 1985 1990 1995 2000

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 Cont…
 If we depend on common sense, it would seem that the time
series depicted in the above four figures are non-stationary,
at least in the mean values.

 This is because some of them are trending upward while

others are trending downwards.

 Although our interest is in stationary time series, we often

encounter Non-stationary time series, the classic example
being the random walk model (RWM).

 It is often said that asset prices, such as stock prices follow a

random walk; that is, they are non-stationary.
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 Cont…
 We distinguish two types of random walks:

1) random walk without drift (i.e., no constant or intercept

term) and

2) random walk with drift (i.e., a constant term is present). It

is stochastic trend.

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Cont…

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 In short, RWM with or without drift, is a non-stationary
stochastic process.

 The terms non-stationarity, random walk, and unit root can

be treated as synonymous.

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 6.5. Test of Stationarity of Time Series Data
 One of the most important preliminary steps in regression
analysis is to uncover the characteristics of the data used in
the analysis.

 The main goals of undertaking Stationarity test are to get a

variable which has a constant mean, variance and time
invariant covariance of the variables called second order
stationary or covariance stationary.

 If the variables are non-stationary, we cannot use the data for

forecasting purpose unless the series is transformed to a
stationary one.
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 Cont…
 Thus, now we may have two important practical questions:

a) How do we find out if a given time series is stationary?

b) If we find that a given time series is not stationary, is there

a way that it can be made stationary?

 There are basically three ways to examine the stationarity of a

time series, namely:

a) Graphical analysis,

b) Correlogram, and

c) Unit root test.

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 Cont…
A) Graphical Analysis

 Before one pursues formal tests, it is always advisable to plot

the time series under study, as we have done above.

 Such a plot gives an initial clue about the likely nature of the
time series.

 Take, for instance, the trade balance time series.

• You will see that over the period of study, trade balance
has been declining, that is, showing a downward trend,
suggesting perhaps that the mean of the TB has been
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 Cont…
 This perhaps suggests that the TB series is not stationary.

 Such an intuitive feel is the starting point of more formal tests

of Stationarity.

 Some of the following time series graph have an upward

trending (MS2, EX and G) which may be an indication of the
non-Stationarity of these data sets.

 That means, the mean or variance or both may be increasing

with the passage of time.

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Cont…

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Cont…

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 Cont…
 Given a correlogram, if the value of ACF is close to zero from
above or below, the data are said to be stationary. (i.e., the
autocorrelation coefficient is statistically insignificant).

 As can be seen from the above Correlogram, the

autocorrelation Coefficient (i.e., AC) is close to one and the P-
values are significant; indicating that the LEXR series is non-
stationary.

 However, LEXR series is stationary at first difference.

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Cont…

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 Cont…
C) The Unit Root Test (Augmented Ducky –Fuller Test)
 A test of Stationarity or non-stationarity that has become widely
popular over the past several years is the unit root test.

 Several tests have been developed in the literature to test for

unit root. Prominent among these tests are

 ADF, PP, DFGLS and KPPS.

 But here our focus shall be to see how the ADF unit Root Test
can be implemented.

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 Cont…
 The ADF test statistic is the ‘t’ statistic for the lagged
dependent variable. ADF statistic is a negative number and
more negative ADF test statistic is the stronger the rejection of
the hypothesis that there is a unit root.

• Null Hypotehsis (H0): If accepted, it suggests the time

series has a unit root, meaning it is non-stationary. It has
some time dependent structure.

• Alternate Hypothesis (H1): If accepted, the null hypothesis

is rejected; it suggests the time series does not have a unit
root, meaning it is stationary.
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Cont…

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 Cont…
Null Hypothes is : LEXR has a unit root
Exogenous : Cons tant
Lag Length: 1 (Autom atic - bas ed on SIC, maxlag=9)

t-Statis tic Prob.*

Augmented Dickey-Fuller tes t s tatis tic 0.241106 0.9719

Tes t critical values : 1% level -3.610453
5% level -2.938987
10% level -2.607932

*MacKinnon (1996) one-s ided p-values .

Null Hypothes is: LMS2 has a unit root

Exogenous: Cons tant
Lag Length: 1 (Automatic - based on SIC, m axlag=9)

t-Statis tic Prob.*

Augm ented Dickey-Fuller tes t statis tic 1.160781 0.9973

Test critical values : 1% level -3.610453
5% level -2.938987
10% level -2.607932

*MacKinnon (1996) one-s ided p-values .

 All the above test results showed that the data sets are non-
stationary. The test statistics is lower than the critical values.
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 Cont…
 Transforming Non-stationary Time Series

 To avoid the spurious regression problem that may arise from

regressing a non-stationary time series on one or more non-
stationary time series, we have to transform non-stationary
time series to make them stationary.

 The transformation method depends on whether the time

series are difference stationary process (DSP) or trend
stationary process (TSP).

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 Cont…
 Here, we will focus on DSP since most macroeconomic time
series are DSP rather than TSP

 DSP: If a time series has a unit root, the first differences of

such time series (i.e., a series with stochastic trend) are
stationary. Therefore, the solution here is to take the first
differences of the time series.

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 Cont…
Null Hypothes is : D(LTB) has a unit root
Exogenous : Cons tant
Lag Length: 0 (Automatic - bas ed on SIC, m axlag=9)

t-Statistic Prob.*

Augmented Dickey-Fuller tes t s tatis tic -6.566992 0.0000

Tes t critical values : 1% level -3.610453
5% level -2.938987
10% level -2.607932

*MacKinnon (1996) one-s ided p-values .

DLTB
.6

.4

.2

.0

-.2

-.4

-.6
1965 1970 1975 1980 1985 1990 1995 2000

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 Cont…
Null Hypothes is : D(LMS2) has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - bas ed on SIC, maxlag=9)

t-Statis tic Prob.*

Augmented Dickey-Fuller test statistic -4.530526 0.0008

Test critical values : 1% level -3.610453
5% level -2.938987
10% level -2.607932

*MacKinnon (1996) one-s ided p-values .

Null Hypothesis: D(LEXR) has a unit root

Exogenous : Cons tant
Lag Length: 0 (Automatic - bas ed on SIC, maxlag=9)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -3.862034 0.0052

Tes t critical values: 1% level -3.610453
5% level -2.938987
10% level -2.607932

*MacKinnon (1996) one-sided p-values.

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 Cont…
 In general, the above test results revealed that Trade balance
(TB), log of money supply (LMS2), and exchange rate data
(EX) became stationary at first difference. In all the above test
results, the null hypothesis of Unit Root is rejected.

 We can follow the same procedures for all variables in the

data set to test for ADF Unit Root Test.

 In practical applications, it is customary to present the Unit

Root test result in the form of table.

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 Cont…
 Table: 1: ADF Unit Root Test Results

 Note: ***, ** and * implies significance at 1%, 5% and 10%, respectively.

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 6.6. What next after unit root testing?
 The outcome of unit root testing matters for the empirical model to
be estimated.

 The following cases explain the implications of unit root testing for
further analysis.
 CASE 1: Series in the model under examination are stationary.
 What if all the time series under consideration are stationary?
Technically speaking, we mean they are I(0) series (integrated
of order zero).

 Under this scenario, cointegration test is not required, as any

shock to the system in the short run quickly adjusts to the
long run. By: Teklebirhan A. 49
 Cont…
 Therefore, only the long run model should be estimated.
Thus, the estimation of short run model is not necessary if
series are I(0).

 CASE 2: Series in the model under consideration are I(1).

 Under this scenario, the series are assumed to be non-

stationary.

 One special feature of these series is that they are of the same
order of integration, I(1).

 Under this scenario, the model in question is not entirely

useless although the variables are unpredictable.
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 Cont…
 To verify further the relevance of the model, there is need to
test for cointegration.

 Note that both long run and short run models must be
estimated when there is cointegration.

 If there is no cointegration, there is no long run and therefore,

only the short run model will be estimated.

 CASE 3: The series are different order of cointegration.

 Researchers are more likely to be confronted with this

situation. For instance, some of the variables may be I(0) while
others may be I(1). By: Teklebirhan A. 51
 Cont…
 Like case 2, cointegration test is also required under this
scenario.

 Recall that, Engle-Granger and Johansen cointegration tests

are only valid for I(1) series.

 Where the series are of different order of cointegration, the

appropriate test to use is the Bounds cointegration test.

 Similar to case 2, if series are not cointegrated based on

Bounds test, we are expected to estimate only the short run.
However, both the long run and short run models are valid if
there is cointegration.
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 6.7. Co-integration Test of Time Series Data
 Cointegration test is the appropriate method for detecting the
existence of long-run relationship.

 If the variables do not co-integrate, we usually face the

problems of spurious regression and econometric work
becomes almost meaningless.

 A number of methods for testing cointegration have been

proposed in the literature.
a) Engle–Granger (EG) Co-integration Test
b)Johansen and Jusesuis (1990) co-integration test
c) The Durbin–Watson (CRDW) cointegration test,
d) Bounds cointegration test, etc.
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 Cont…
 The Engle-Granger test is meant for single equation model
while Johansen is considered when dealing with multiple
equations.

 Finally, Bound Test is for ARDL model. It is appropriate when

variables are I(0) and I(1) or mutually I(0) or mutually I(1)

 Recall that, Engle-Granger and Johansen cointegration tests

are only valid for I(1) series. –Similar order of integration.

 Where the series are of different order of cointegration, the

appropriate test to use is the Bounds cointegration test.

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Cont…

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Cont…

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 Cont…
 Click OK, to obtain the following Long Run Regression Result
(Determinants of Trade Balance of Ethiopia in the Long Run)

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 Cont…
2) Save/Rename the residuals obtained from the above
regression

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 Cont…
3) Open the saved residual (i.e., RES) and perform ADF unit
root test to obtain:

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 Cont…
4) Decision based on Residuals ADF unit RootTest Result
 Based on the above Result, we reject the null hypothesis of
Unit Root.
 Thus, the residual series is stationary, i.e., the long
run equation is conintegrated.
 I.e., the long run Model is not Spurious.

 Thus, the variables in the model have long run r/ships or

equilibrium.

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 Cont…
 The Short Run Model and Error Correction Mechanism

 If a linear combination of non-stationary series is found to be

stationary (cointegrated), one would be correct to just go
ahead and interpret the results of the long run model and
short-run dynamics of the model.

 Since equilibrium (i.e. steady state) is rarely observed, it may

be necessary to consider the short-run evolution of the series
and dynamics of adjustment.

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Cont…

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Cont…

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 Cont…
 Then, click OK/to see Vector Autoregression Estimates/View/Lag
Structure/Lag Length Criteria/check maximum lags to
include/OK you will see the selected Lag Length as follows:

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 Cont…
2) Rename the residual obtained from the long run/static
model as ECT for convenience.

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 Cont…
3) Then, Click Quick/Estimate Equation and specify the error

correction model (considering the appropriate lag length selected)

in the Equation Specification dialog box as shown below.

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 Cont…
4) Click OK to obtain the following result
(Short Run Determinants of the Trade Balance of Ethiopia)

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 Cont…
 The coefficient of the error-correction term of about -0.89
suggests that about 89% of the discrepancy between long-
term and short-term Trade Balance is corrected within a year
(yearly data), suggesting a high rate of adjustment to
equilibrium.

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 Cont…
Post Estimation Tests
 This requires verifying whether the estimates from the error
correction model are reliable.

 The most relevant post-estimation tests for dynamic model

include
Model Specification test (Using Ramsey Reset Test),
Serial Correlation test (using the LM test),
Normality test (using Jarque-Bera test).
HeteroskedasticityTest (using Breusch-Pagan-Godfrey)

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 Cont…
A) Autocorrelation Test
 The Breusch-Godfrey LM test is one of the prominent tests.
 The null hypothesis is that there is no serial correlation.
 Using EViews, Estimate the short run model/View
/Residual Diagnostics/ Serial Correlation LM test/ click
OK on the Lags Specification box and the serial correlation test
results would appear as follows:

 Both the F & Chi2 probability values are insignificant, so the model is
free from autocorrelation.
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 Cont…
B) Ramsey Reset Test
 The null hypothesis is that the model is correctly specified.
 To test this hypothesisEstimate the short run
model/View/Stability Diagnostics/Ramsey Reset Test  to
obtain:

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 Cont…
C) Normality Test
 To perform the test, select View/Residual Diagnostic
/Histogram Normality-Test, the following result will appear:

 Thus, the null hypothesis of normal error term cannot be rejected

as the P-value of the JB normality test is insignificant. 72
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 Cont…
D) Heteroskedasticity Test

 To perform the test, select View/Residual Diagnostic

/Heteroskedasticity Test, the following result will appear

 Thus, the null hypothesis of constant variance cannot be rejected

as the P-value of the test is insignificant.

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 6.8. Autoregressive Distributed Lag
(ARDL(p,q)) Models
 Autoregressive distributed lag models:
 models that contain the lagged values of the dependent variable,
the current and lagged values of regressors as explanatory
variables.

 This model was developed by Peasaran et al. (2001)

ARDL Models can be specified and used:
 If the variables are integrated of different orders. I.e., variables with I(0)
and I(1), or exclusively I(1), and No I(2).
Unit root test is vital to ascertain that no variable is I(2).

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Cont…

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 (ARDL(p,q)) Using EViews
 The relevant steps are :
Step 1: Specification of the model in static form
 Click on Quick on the Menu bar and select Estimate Equation

 Specify the appropriate static equation in the Equation

Specification Window.
Step 2: Choose the appropriate estimation technique
 Click on the drop-down button in front of Methods under the

Estimation settings and select

 ARDL – Auto regressive Distributed Lag Models

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 Cont…
 Step-3: Optimal Lag Length Selection Criterion
 The lag structure of the ARDL model specification was
determined by Schwarz Criterion (SIC) since it controls the
problems of autocorrelation and it is also advantageous for small
sample size.

 Let the estimation use Automatic Selection.

 The Linear Trend option under the Trend specification is also

selected, since our variables order of integration is at first
difference, they are non stationary at level.

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Cont…

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 Cont…
 Step -4: Estimate the model based on Steps 1 to 4 (i.e., click Ok
in the above dialog box), to obtain:
Dependent Variable: LTB
Method: ARDL
Date: 12/23/23 Tim e: 08:40
Sam ple (adjus ted): 1964 2003
Included obs ervations : 40 after adjus tm ents
Maxim um dependent lags : 4 (Autom atic s election)
Model s election m ethod: Schwarz criterion (SIC)
Dynam ic regres s ors (4 lags , autom atic): LMS2 LGDP LG LEXR
Fixed regres s ors : C @TREND
Num ber of m odels evalulated: 2500
Selected Model: ARDL(1, 0, 0, 0, 0)
Note: final equation s am ple is larger than s election s am ple

Variable Coefficient Std. Error t-Statis tic Prob.*

LTB(-1) 0.327830 0.132025 2.483088 0.0183

LMS2 0.547819 0.422316 1.297176 0.2036
LGDP -0.095955 0.177223 -0.541438 0.5918
LG 0.210970 0.241553 0.873389 0.3888
LEXR 0.429151 0.119701 3.585190 0.0011
C -4.181655 1.884220 -2.219303 0.0335
@TREND -0.131131 0.045367 -2.890487 0.0068

R-s quared 0.880348 Mean dependent var -0.938490

Adjus ted R-s quared 0.858593 S.D. dependent var 0.482214
S.E. of regres s ion 0.181333 Akaike info criterion -0.419339
Sum s quared res id 1.085091 Schwarz criterion -0.123785
Log likelihood 15.38678 Hannan-Quinn criter. -0.312476
F-s tatis tic 40.46649 Durbin-Wats on s tat 1.935353
Prob(F-s tatis tic) 0.000000

*Note: p-values and any s ubs equent tes ts do not account for m odel
s election.

By: Teklebirhan A. 83
 Cont…
 Based on this selection order criteria, the optimal lags of each
variable in the model is (1, 0, 0, 0, 0) .

 However, to judge how strong the selected model is than

other models we can use the SI Criterion Graph

 As the graph shows the model is strong since the lower the
value is the better the model is.

By: Teklebirhan A. 84
Cont…

By: Teklebirhan A. 85
 Cont…
 Step-5: Co-Integration Test: Using Bounded Test Approach
 In order to determine the possible presence of co integration
thus a long-run equilibrium among the variables the study
adopts the bounds testing approach within the ARDL
framework to test for co-integration.

 The ARDL bound test approach is testing the existence of the

co-integrating relationship among the dependent variable and
the regressors that is applied by comparing the F-statistics
with the bound critical values of Pesaran, Shin, and Smith
(2001).
By: Teklebirhan A. 86
 Cont…
 To do this, on the equation workfile estimated above
View/Coefficient Diagnostics/Bounds Test, then you will
obtain the ff test result:
ARDL Bounds Tes t
Date: 12/23/23 Tim e: 08:52
Sam ple: 1964 2003
Included obs ervations : 40
Null Hypothes is : No long-run relations hips exis t

Tes t Statis tic Value k

F-s tatis tic 5.794993 4

Critical Value Bounds

Significance I0 Bound I1 Bound

10% 3.03 4.06

5% 3.47 4.57
2.5% 3.89 5.07
1% 4.4 5.72

By: Teklebirhan A. 87
 Cont…
 As can be seen from the test result above, the F-statistic is
higher than the upper bounds test critical value even at 1%
level of significance.

 Therefore, we reject the null hypothesis of no long run

relationship.

 Right in such cases, we can estimate both the SHORT RUN

and LONG RUN Models.

By: Teklebirhan A. 88
 Cont…
Step-6: Estimate the long run model
 Click on View on the Menu Bar
 Click on Coefficient Diagnostics
 Select the Cointegration and Long Run Form option

By: Teklebirhan A. 89
.
 Cont…
 Step-7: Diagnostic Tests for ARDL

 ARDL is a linear regression model and therefore the

underlying assumptions of CLRM have to be verified.
 The most relevant post-estimation tests for dynamic model
include
 Model Specification test (using Ramsey Reset Test),

 Serial Correlation test (using the LM test),

 Normality test (using Jarque-Bera test).

 Heteroskedasticity Test (using Breusch-Pagan-Godfrey)

 Model stability Test (CUSUM & CUSUM SQUARED TEST)

By: Teklebirhan A. 91

 Cont…
A) Autocorrelation Test

 The Breusch-Godfrey LM test is one of the prominent tests.

 The null hypothesis is that there is no serial correlation.

 Using EViews, Estimate the short run model/View /Residual

Diagnostics/ Serial Correlation LM test/ click OK on the Lags
Specification box and the serial correlation test results would
appear as follows:

By: Teklebirhan A. 92
 Cont…

 Both the F & Chi2 probability values are insignificant, so the model is
free from autocorrelation.-

By: Teklebirhan A. 93
 Cont…
B) Ramsey Reset Test
 The null hypothesis is that the model is correctly specified.
 To test this hypothesisEstimate the short run
model/View/Stability Diagnostics/Ramsey Reset Test  to
obtain:

By: Teklebirhan A. 94
 Cont…
 The null hypothesis that the model is correctly specified
cannot be rejected since the test statistics (t-statistic, f-statistic
and likelihood ratio statistic) are all statistically insignificant.

C) Normality Test
 Toperform the test, select View/Residual Diagnostic
/Histogram Normality-Test, the following result will appear:

By: Teklebirhan A. 95
 Cont…
8
Series: Residuals
7 Sample 1964 2003
Observations 40
6
Mean -1.11e-15
5 Median 0.011891
Maximum 0.359708
4 Minimum -0.506750
Std. Dev. 0.166802
3 Skewness -0.495783
Kurtosis 3.982793
2
Jarque-Bera 3.248472
1 Probability 0.197062

0
-0.5 -0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4

 Thus, the null hypothesis of normal error term cannot be rejected

as the P-value of the JB normality test
By: Teklebirhan A.
is insignificant. 96
 Cont…
D) Heteroskedasticity Test

 The null hypothesis that the model is homoscedastic cannot

be rejected since the test statistics ( f-statistic and Chi-square)
are all statistically insignificant.

By: Teklebirhan A. 97
 Cont…
E) Model stability Test

 Next, we examine the robustness of the result as well as

stability of short-run and long-run coefficients, performing
the CUSUM and CUSUMQ stability tests for the AIC-based
error correction models.

 The tests applied to the residuals indicate the absence of any

instability of the coefficients because the plots of the
CUSUMQ and CUSUM statistic are confirmed within the 5%
critical bounds of parameter stability.

 Such tests are recommended by Pesaran et al. (2001).

By: Teklebirhan A. 98
 Cont…
 In order to reject or accept the null hypothesis, we can decide
by looking the p-values associated with the test statistics.

 That is the null hypothesis is rejected when the p-value are

smaller than the standard significance level (I.e. 5%).

By: Teklebirhan A. 99
 Cont…
 CUSUM TEST
20

15

10

-5

-10

-15

-20
72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02

CUSUM 5% Significance

 As can be seen from the first figure, the plot of CUSUM test
did not cross the critical limits. Thus, the result shows our
model is stable. By: Teklebirhan A. 100
 Cont…
 CUSUM SQUARED TEST
1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4
72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02

CUSUM of Squares 5% Significance

 However, the CUSUMSQ test shows that the graphs cross the
lower and upper critical limits. Thus, the result shows our
model is not stable. By: Teklebirhan A. 101
 The End!
Thank You!
“Education without values, as useful as it
is, seems rather to make man a more
clever devil.” ― C.S. Lewis