ASSIGNMENT

Assignment

Assignment

Question no. 1

The graphical representation means a lot in econometric analysis as the fluctuations with the passage of time can be clearly seen through graphical analysis which sometimes becomes difficult for researchers to capture the changes analytically. The researchers therefore use analytical methods to determine the hypothesis and verify it but to view the changes in data graphical method is widely used.

Future prices of a commodity are always expected to be higher due to inflation. The difference between a commodity's price in one time-period and the expected future price in the previous time period is actually rise in price levels. The graph above is a plot of spot prices of oil and the lag of future prices for daily 5-days data from 1988 to 2012. The prices are in U.S. dollar. For first two decades of the total time-period the spot prices and future prices fluctuated from $10 to $40 per barrel. For the same time-period, the increase in price level per day is almost constant. In the decade of 2000 both spot and future oil prices increased drastically. The highest price of which reached to $149 per barrel in 2008.

Graph: 1 (Spot Prices and Future Prices)

Even then the difference between the spot and future prices per day remained unchanged. This represents that the high prices were anticipated. The year 2012 has a different pattern as the difference between the spot price and previous time's future price is increasing implying that the prices of oil are unanticipated.

Using ADF to determine stationary series

In the analysis of time series econometrics in the field may occur trends which may make the spurious regression. These trends can be stochastic, in case there is non-stationarity in variance, or deterministic, in case of the non-stationarity in both media. The Dickey-Fuller test assesses whether there is a trend in the variables that makes the spurious regression. If there is such a trend, you can create the difference between the variables at time t with time t-1 and work on them. If this regression of two variables would observe that they exhibit a significant relationship (R2 and high p-value significant) when in fact there is no good economic reason until the two indices may be connected.

Augmented Dickey-Fuller is a test to check whether a series is stationary or non-stationary, or if a series possesses unit root. The test uses following regression to determine the existence of unit root in a time-series variable (Yaffe & McGee, 200, p. 84). Following are the results of ADFL for spot prices and future prices of oil.

Table: 1 (ADF Statistics)

Unit Root

Spot Prices

Future Prices

Level

Present

-0.286

-0.71

1st Difference

Not present

-19.12

-22.69

2nd Difference

Not present

-6.157

-16.11

Above results are obtained using the unit-root test available in E-views namely Augmented Dickey-Fuller. The test in E-views takes number of lags according to SBIC. Both the variables in given regression is non-stationary at level form, and stationary at 1st difference and 2nd difference. Thus, we can obtain cointegeration of the regression.

Spurious Regression

There is always a problem of matching the statistical significance with ...