Financial Investment Analysis: Box-Jenkins Methodology, VAR Models, and Impulse Function Graphs
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This document covers the Box-Jenkins methodology, VAR models, and impulse function graphs for financial investment analysis. It includes trend graphs, tables, and charts to explain the concepts.
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FINANCIAL INVESTMENT ANALYSIS1 FINANCIAL INVESTMENT ANALYSIS Course name Professor’s name Institution name City Date of submission
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FINANCIAL INVESTMENT ANALYSIS2 QUESTION ONE The box-Jenkins methodology The Box-Jenkins methodology is usually applied to an ARMA (p, q) model with an aim of determining the most appropriate values of p and d. It also refers to the method of identifying, fitting, checking and using ARIMA. The first step in this methodology as suggested by Box- Jenkins is to check for stationarity by fitting a time series plot, correlogram and partial correlation plots(Zaharia & Balacesu, 2017). Time P X _ L A S T 010203040506070 02 0 0 06 0 0 01 0 0 0 01 4 0 0 0 Figure1: Time series plot of bitcoins The chat above showed that the log returns of bitcoin increase accordingly across a time period. As shown in the chart above the bitcoin returns rapidly increase during the time period. There is an evident of an increasing trend in the data. It implies that before analyzing the data, de-trending methods will be first be applied to the data set in order to remove the
FINANCIAL INVESTMENT ANALYSIS3 trend component in the data set. One of the methods is using linear regression to model the bitcoins return data accompanied by linear indices (1,2, 3…n) (Ding et al., 2017). The resulting model will represent a time series data without trend component. In this case, trend component will be eliminated from the data. However, in some cases it could still be presence in the residuals. In order to solve this scenario, some predictors will be added to the model. Towards the end of the time period there is evident of seasonality component. 051015 - 0 .20 .00 .20 .40 .60 .81 .0 Lag A C F Series PX_LAST Figure2: Correlogram Correlogram is usually used to display whether previous lagged values of the time series has an effect on current state. The chart above show that majority of the autocorrelation crosses the blue line, implying that these specific lags are significantly associated with the current bitcoin returns series. This chart also indicates that there is data is non-stationary since its series is dropping the gradually from the highest to zero(Maravall, et al., 2016). It also
FINANCIAL INVESTMENT ANALYSIS4 implies that before fitting a model which assume stationarity first the data need to be transformed. ARMA(1,1)=2081.831+0.9394Xt−0.1024Xt−1 OrderBICAIC 0,01197.341369.98 1,11386.321206.98 2,21376.731210.69 3,31347.891230.31 1,01367.691226.83 0,11385.121206.99 2,01341.871250.32 0,21364.541227.47 3,01199.511315.95 0,31368.021226.01 Question 2 Table 1: Continuously compounded rate of returns Calculations USDGB P EURGB P JPYGB P GBPUS D GBPEU R GBPJP Y Annual change17.27%27.30%11.25%-36.05%-48.52%-26.11% 117.27%127.30%111.25%63.95%51.48%73.89% Continuously compounded 15.93%24.14%10.66%-44.70%-66.39%-30.27%
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FINANCIAL INVESTMENT ANALYSIS5 rate of returns On the continuously compounded rate of returns, EUROGBP had the highest compounded rates of return from 2000 to 2018. USDGDP came second at 15.93% followed by JPYGBP at 10.66%. GBPJPY (-30.27%), GBPUSD (-44.70%) and GBPEUR (-66.39%) implicated the least returns from 2000 to 2018. a.Best VAR Models On VAR model selection, an optimal model exists on minimal Akaike Information criterion (AIC). The lower the AIC, the better the model. According to the analysis, model 1 indicates the lowest AIC levels (AIC=13,681.83) as compared to model 2 and model 3. This indicates that the model appropriate in the prediction of interest rates within the selected exchange rates (Angelidis and Degiannakis, 2018). Table 2: Regression model 1 UsdgbpCoefStd. Errt eurgbp - 0.10829 94 0.0124 98-8.67 jpygbp0.50316 27 0.0111 5745.1 _cons0.41105 73 0.0067 7660.66
FINANCIAL INVESTMENT ANALYSIS6 Table 3: Regression model 2 usdgbpCoefStd. ErrtP>|t|[95 % Conf. Interval] eurgbp-0.10830.012498-8.670-0.1328-0.0838 jpygbp0.5031630.01115745.100.4812910.52503 _cons0.4110570.00677660.6600.3977730.424341 On model 2, the AIC=12,484.81 and BIC=-12465.29. The model implies the least in terms of the VAR measures since it registers the highest AIC scores of the three models. This makes the models less optimal hence the suitability of model 1 in the forecasting of the exchange rates presented within the three models. Table 4: Regression model 3 usdgbpCoefStd. ErrtP>|t|[95 % Conf. Interval] eurgbp0.5785580.01282 94500.5534090.60370 8 jpygbp0.6249810.01017 261.4400.6050390.64492 4 _cons-0.237050.00898 2-26.390-0.25466- 0.21944 On model 3, the AIC=-12.8989 and BIC=-12970.32, hence second best optimal model for selection. In terms of rank, it stands at position 2 as compared to the first model with the least AIC scores. b.Final model
FINANCIAL INVESTMENT ANALYSIS7 Table 1: First model usdgbpCoefStd. ErrtP>|t|[95 % Conf. Interval] eurgbp-0.10830.01249 8-8.670-0.1328-0.0838 jpygbp0.5031630.01115 745.100.4812910.52503 _cons0.4110570.00677 660.6600.3977730.42434 1 On the final model, R-squared=0.3865 implying that 38.65% of the regression of JPYGBP, EURGBP on USDGBP as explained by the model. The relationship indicates low predictive power within the model with respect to the changing interest rates for the selected periods in which the exchange rates in operation. The model equation is defined by the mathematical relationship in terms of; USDGBP=0.411−0.108∗EURGBP+0.503∗JPUGBP The intercept in the model implicate a positive effect on the USDGBP (β=0.411). This shows that when the model has no EURGBP and JPYGBP, the value of USDGBP equivalent to 0.411 i.e. bothEURGBPandJPUGBPdoes not affect the value ofUSDGBP. The parameter presents evidence of statistical significance (t=60.66, p=0.000) hence required by the model. The EURGBP presents a negative effect on the USDGBP (β=-0.108). This leads to the reduction in the USDGBP indices from the exchange rates with a significant effect on the model (t=-8.67, p=0.000). The JPYGBP presents a positive effect on the model (β=0.503) with a significant effect on the USDGBP rates (t=45.10, p=0.000). c.Granger casualty tests Table 4: Granger casualty tests
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FINANCIAL INVESTMENT ANALYSIS8 Equation Excludedchi2dfProb> chi2 usdgbg eurgbp11.43720.003 usdgbg jpygbp1.032420.597 usdgbg ALL14.45140.006 eurgbg usbdgb1.262520.532 eurgbg jpygbg1.681820.431 eurgbg ALL2.31740.678 jpygbg usdgbp3.358220.187 jpygbg eurgbp16.15820 jpygbp ALL23.30740 On the analysis, USDGDP is seen to granger cause EUROGBP (Chi-2=11.437, p=0.003) and All the variables (Chi2=14.451, p=0.006) at 5% level of significance expect for JPYGBP (Chi2=1.032, p=0.597). EUROGBP does not cause a granger casual effect on any of the selected variables (p>0.05) at 5% level of significance. JPY causes a granger casualty effect ib EURGBP (Chi2=16.158, p=0.000) and ALL (Chi2=23.307, p=0.000) unlike USDGBY (Chi2=3.358, p=0.187). d.Impulse function graphs
FINANCIAL INVESTMENT ANALYSIS9 0 .0001 .0002 .0003 0510 order1, eurgbp, usdgbp 95% CIorthogonalized irf step Graphs by irfname, impulse variable, and response variable Figure 1: Impulse function graph of EURGBP and USDGBP On the graph, the EURGBP and the USDGBP falls between 0.00 and 0.0003, with a constant levels of significance depicted by the trend.
FINANCIAL INVESTMENT ANALYSIS10 -.0001 0 .0001 .0002 0510 order1, jpygbp, usdgbp 95% CIorthogonalized irf step Graphs by irfname, impulse variable, and response variable Figure 2: Impulse function graph of JPYGBP and USDGBP On the graph, the relationship between JPYUSD and USDGBP falls between 0.000 and 0.005 as depicted by the graph. The output shows some constant orthoganized irf at 5% level of significance (Ronayne, 2011). Question 3 a.Trend graph Below is the trend graphical representation
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FINANCIAL INVESTMENT ANALYSIS11 050100150 050100150200250 time FUT_PXst Figure 3: Trend graph of future prices and the spot rates (natural logarithm) On the graph, the future prices of the oil show changes over time, from a comparatively lower price to some high price with time. The pattern depicted range from high to low, with a possibility of continuous fall in prices. The spot rates indicate a unitary effect, with no change on the horizontal axis. Table 5: VAR tests for spot rates (natural logarithm) and future prices (natural logarithm)
FINANCIAL INVESTMENT ANALYSIS14 Table 6: AIC and BIC of the VAR ModelObs11 (null) 11 (model)dfAICBIC 218_1141.6342- 2199.26-2057.11 From the output of table 6, on the AIC, the analysis indicates (AIC=-2199.261) with (BIC=- 2057.12). This makes the model appropriate at lag 2 and 6. These present the positions in which the model regarded as optimum with sufficient results yielded from the analysis. Table 7: ADF tests for the natural logarithm of the spot rates 1 % Critical Value5 % Critical Value 10 % Critical Value z (t)-0.884-3.468-2.882-2.572 Formulation of the hypotheses Ho: There is a unit root (data is non-stationary) H1: There is no unit root (data series stationary) According to the analysis, there is evidence to fail to reject the null hypothesis at 5% level of significance (z=-2.882, p=0.7931). The p-value is greater than 0.05 at 5% level of significance hence making the stationarity assumptions of the trend failed across the series. b.Engle-Granger 2 step model
FINANCIAL INVESTMENT ANALYSIS15 Table 8: Engle-Granger 2 step model 1 % Critical Value5 % Critical Value 10 % Critical Value z (t)-7.946-3.945-3.363-3.063 On the model, there indicates evidence of no granger Cointegration between the spot rates and the future prices of oil (Z(t)=-7.946). The analysis indicates the evidence of the two variables independent of each other in influencing the oil prices within the market (Bouzid, 2012). c.Economic rationale of the test According to Crowder &Hamed (1993, p.940), the analysis indicates similarity on lack of Cointegration between the spot rates and future prices. The effect of the relationship as depicted on the study expected to lower the revenue streams realized from the oil, having an influence on the individual economies of the countries. The outcome contradicts to Kellard et.al (1999, p.420) with the presence of a Cointegration on their analysis. The disparity viewed on the revenue differences between the two markets, leading to differences in the advantages of the commodities present in such markets. The situation directly indicates the possibility of more market efficiency in the presence of Cointegration, with a notion of improve profitability within the designated markets hence better Gross Domestic Product (GDP) values. d.Error Correction Model Table 9: Vector error correction model
FINANCIAL INVESTMENT ANALYSIS16 Equatio nParmsRMSER-sqchi2 D_st40.0907040.03477.97319 On the final model, the AIC and BIC reduces greatly, making it optimal in meeting the needs of the market (Ouedraogo, 2013). In the short run, the spot rates prove elastic, with a possibility of future improvements in elasticity levels hence suitable for predicting future market efficiencies in the other markets. References Angelidis,T.andDegiannakis,S.A.,2018.BacktestingVaRModels:AΤwo-Stage Procedure.Available at SSRN 3259849. Bouzid, A., 2012. The relationship of oil prices and economic growth in Tunisia: A vector error correction model analysis.The Romanian Economic Journal,43, pp.3-22. Crowder, W.J., and Hamed, A. (1993): ‘A Cointegration Test for Oil Futures Market Efficiency,’ Journal of Futures Markets, 13:933-941. ·
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FINANCIAL INVESTMENT ANALYSIS17 Ding, F., Wang, F. & Minghu, W., 2017. Decomposition based on least squares iterative identificationalgorithmformultivariatepseudo-linearARMAsystemsusingthedata filtering.Journal of the Franklin Institute,354(3), pp. 1321-1339. Kellard, N., Newbold, P., Rayner, A. and Ennew, C. (1999), ‘The Relative Efficiency of Commodity Futures Markets’, Journal of Futures Markets, 19:413432 Maravall, A., Lopez, P. R. & Perez, D. C., 2016. Reg-ARIMA model Identification: Empirical Evidence.Statistica Sinica,pp. 1365-1388. Ouedraogo, N.S., 2013. Energy consumption and human development: Evidence from a panel cointegration and error correction model.Energy,63, pp.28-41. Ronayne, D., 2011.Which impulse response function?(No. 2068-2018-2263).Available from: https://warwick.ac.uk/fac/soc/economics/research/workingpapers/2011/twerp_971.pdf Zaharia, M. & Balacesu, A., 2017. Using Arima in Robor Modelling.The USV Annals of Economics and Public Administration,17(1), pp. 156-165.
FINANCIAL INVESTMENT ANALYSIS18 Appendix
FINANCIAL INVESTMENT ANALYSIS19
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