Evaluating performance of univariate, multivariate and VAR approaches forecasting Swiss Gross Domestic Product using EViews 2016-100-EBC2086 Prof. Alain Heeq, Martin Wischnath 16139285 Maastricht, 27th October 2016 Be Maastricht UniversityTable of Contents 1 Introduetion. 2: Dateien 3. Beonomic background .... 4 Univariate anal 4.1 Model specification 4.2 Model testing. 43° Volatility (GARCH-approach)... Univariate forecast. 5.1 Building multivariate framework... 5.2 Cointegration Relationship .... 53 Simple conditional Model... 5A Conditional model forecast... 6 Multivariate VAR model .. 6.1 Estimation of VAR models... 6.2 Granger causality 6.3 Impulse responses. 64 VAR forecasting . 7 Forecast comparison 8 Conlusion.... 12 9 Appendices ses 13 9.1 Graphs... 9.2 TABLES vesen 10 Data Sources 11 Bibliography.1 Introduction This paper tries to summarize our efforts on time series analysis during the course "Time Series Modelling" by Prof. Alain Hecq. It should in particular accompany the research project we conducted during the course, namely the model specification for uni- and multivariate data analysis as well as the application and evaluation of different forecasting techniques. ‘Throughout our work we will make use of software package Eviews 9, which is specialised ‘on the type of time series work we will perform For our research project, we start with three univariate time series of GDP data of France, the United Kingdom and Switzerland and perform simple univariate analysis and construct a multivariate model thereof. Additionally, we will build a vector auto regressive model (VAR) of our three time series. We will also employ techniques to identify relationships between time series, as we discussed throughout the course, in particular tests on cointegration and Granger-causality. Finally, we will perform an out-of-sample forecast for the last 12 quarters of the sample, namely from 2012 to 2014, to compare and asses the overall quality of our models. To examine the quality of the forecasted time series we mainly rely on Root mean squared errors (RMSE) as an indicator for forecasting precision. 2 Data ‘The data used during this research was provided by the statistical agency of the European Commission eurostat. We will use Gross Domestic Product data from the national accounts database. The time frame we will examine is set from the first quarter of 1985 until the fourth quarter of 2014 with a total number of 120 observations. For better comparison we will use real prices as of 2010 and also use seasonally adjusted data. In the case of France we perform Seasonal adjustment using the X13 method manually, a technique that is also employed by eurostat. Taking the exponential attributes of GDP data into account we will co use of log transformed level data, which is plotted in inue with the igure 1. We will perform all our statistical tests on a 5% confidence level. 3. Economic background For our model specification and forecasting purposes we will start off with Switzerland Gross Domestic Product as the main variable, During our research we want to examine whether the 3non-EU member state Switzerland's economic state can be forecasted using selected European countries, namely by using two major national economies France and the United Kingdor This could be a real-world application performed by the Schnweizerische Nationalbank, for instance. Even though Switzerland is not a member state of the BU, it is surrounded by European countries that are and thus itis likely that their economic prosperity has a large influence on the Swiss economy and vice versa in today’s globalized in interdependent trade system. ‘To examine the interdependencies of Switzerland and selected central European countries and. the EU in total we compute the correlation matrix of GDP growth rates of these countries in Table 1. It turns out that different from the expected the Swiss economic growth is not highly correlated with its neighbor state Germany or the Netherlands as another central European state, Different from that, France has a high correletion of 0.90 with the economic growth in the EU as a whole and can therefore be seen as good proxy for the EU in total. In the European landscape the United Kingdom in particular is vastly different from the majority of other countries conceming the political and economie system. The anglo-saxon country employs weaker regulation and features a deregulated financial sector and overall less labor protection. This is why we can assume higher dynamic in the economic activity picking up global economic periods of growth as well as decline in a faster way which could be seen as an indicator for future economic activity in the stronger regulated and thus less flexible center of Europe. Switzerland in fact, could be seen as being similar in both econnomic in political dimensions to Austria, Germany and the Benelux area, All of these countries feature the same system of a developed social welfare system and also high regulation on labor markets Additionally, both the UK and Switzerland rely on a strong financial sector which tightens the inderdependencies between the two countries. This finding gets underlined as the United Kingdom's economic growth has relatively low correlation with other central European states ‘could be seen as an external variable for our forecasting purposes. Consequently, in this paper we try to build multiple models with the goal to examine the influence of the EU, through France as a proxy, and the United Kingdom on Swiss GDP and how their economic development can help forecasting the state of the Swiss economy. Since we rely solely on the GDP and do not include other variables such as import or export Statistic or indicators for economic prosperity we are aware that this can only represent a simplified approach to real-world conditions,4 Univariate analysis, 4.1 Model specification In our first approach on finding a suitable univariate model to correctly describe the data and perform univariate forecasts we will employ an ARMA(p.q) approach. Firstly, we will test on the order of integration of our time series, namely we will perform an Augmented-Dickey-Fuller test (ADF) to test for the presence of a unit root. In our finding we cannot reject the null-hypothesis of a unit root with an P-value of 0.324. As we have confirmed to have a time series integrated of order one, we will continue using first differences (GDP growth rates) of the data. For the growth rates we perform a Wald coefficient test for the presence of seasonalities, We find a P-value of 0.974 and thus cannot reject the null that the seasonality coefficients are jointly insignificant. Thus, we will continue the univariate approach without the use of seasonalities. To find the best suitable ARMA model we take a look at the correlogram of the time series and examine ACF and PACF values, We detect an AR(1) model as we see constant declining correlations in ACF and only the first partial correlation being signi int. Since the declining ACF values are not undoubtedly to be identified we also consider an MA(2) model, which tums out to have higher SIC (-7.445) and AIC (-7.538) values, AY = a+ BAY + &% Equiaion 1 Univariate AR(1) model ‘The finding of an AR(1)-model gets confirmed as we perform an automatic ARMA-model selection following both Schwarz- and Akaike information criteria. The AR(1) model has the lowest information criteria values in both cases, namely an $IC-value of -7.402 and an AIC value of -7.476, 4.2. Model testing ‘To assess the overall quality of the selected AR-model we perform multiple misspecification tests. To check for linearity we perform a RESET-test and receive a P-value of 0.0997 and thus cannot reject the null of no misspecification on a 5% confidence level.Additionally, we test, whether we removed remaining autocorrelation completely. According to the correlogram of the models residuals (Figure 5) we can conclude that the chosen model performs well on removing autocorrelation as there are no significant ACP-values left. ‘Tests on heteroscedasticity and normality will most certainly be influenced by outliers present in the data. According to the Boxplot we find three outliers: Beginning in 1999Q4 with a high positive growth rate, due to the fact that the Swiss economy experienced a .boom’ during the end of the 1990s ending a period of economic stagnation in the first half of the decade. This, period from 1990 to 1997 characterized by low GDP overall change is also clearly identifiable in Figure 6. The other two outliers are detected in 2008Q4 and the following quarter 2009Q1, marking the impact of the global financial 1 and the following global recession period, These outliers are also visible in the residuals of the univariate model (Figure 6). One can notice that the periods of high growth or severe decline are in fact captured by the model, even though high residuals remain, which is why we decided not to include Dummy-variables to capture the outliers better as the main purpose of the model will be forecasting and the models should remain simple and consistent. Due to the aforementioned circumstances the null hypothesis of normel distributed residuals gets rejected with a P-value of 0.00. The same is true for the test for heteroscedast ity, due to outliers and higher variance of GDP growth in the early 1980s. To address these issues we will continue with the use of Huber-White robust standard errors, whenever possible, to robustify against the observed heteroscedasticity. 4.3. Volatility (GARCH-approach) We perform an additional ARCH-test for time varying volatility to further examine the heteroscedasticity found in the data, The ARCH test for heterosceasticty gives a tvalue for the lagged squared residual of 0.724, meaning that there is no significant volatility clustering present, 4.4 Univariate forecast We perform univariate out of sample forecasts for Swiss GDP in level for the period from 2012 to 2014, As visi le in Table 3, the dynamic model has a RMSE-value of 835.55 compared to a RMSE of 377.04 in the static model. Intuitively, the static model which forecasts while incorporating true realized values has a lower error.4.5 Model selection for explanatory variables As we will need forecasting models for the proposed explanatory variables in the multivariate model we will also identify suitable models for both French and British GDP. In both cases ‘we cannot reject null of a unit root with P-values in the case of France of 0.93 and for the United Kingdom of 0.80. Accordingly, we will also work with growth rates of the French and British GDP. respectively. In the analysis of the correlogram we find identical patterns of decreasing AC and a PAC only significant for the first lag and thus will choose AR(I) models for both variable: Kae = Gy + BAX, cu4 + ByOutlier; + £4, AXn = Oz + PrbXre-1 t+ Ere Equiation 2. Univariate AR(1) models for UK and France GDP growth We test for misspecification in the AR model of French GDP growth (X,): We find significant heteroscedasticity (P-value 0.000) due to an increased variance and outliers in the 1980s. Since there is heteroscedasticity present we will continue with the use of Huber-White robust standard errors whenever possible. We do include a dummy variable to correct for a significant outlier in Q4 2008 and QI 2009. Doing so allows us to reach better performance in misspecification tests, accordingly we cannot reject the null hypothesis of normal distributed outliers with a P-value of 0.538. The Ramsey-RESET test for linearity cannot reject the null hypothesis of no misspecification with a P-value of 0.243, For the British GDP we find significant heteroscedasticity (P-value 0.000) due to a varying variances throughout the sample. Including dummies for the identified outliers does not help in this case. For the same reason we reject the null hypothesis of normal distributed outliers with a P-value of 0,001. Since there is heteroscedasticity present, accord gto the White-test for heteroscedasticity (P-value 0.000) we will also continue with the use of Huber-White robust standard errors in this case. 5 Multivariate models 5.1 Building multivariate framework We are now looking for ways to improve the univariate model by including additional variables that should help forecasting the Swiss GDP due to a relationship out of economic theory. We therefore build a ,simple conditional mode!’ that employs the Swiss GDP growth as the dependent variable and a matrix of variables as explanatory independent ones. ¥5.2 Cointegration Relationship To test for the necessity to include an Error-Correction-Model (ECM) into the model we test for a cointegration relationship between the time series, namely whether there exists a long- run relationship bewteen the data. For that purpose we will examine the residuals of a COINTREG-model, perform the Engle-Granger test and the Johansen-test for the presence of a cointegration relationship. Figure 7 shows the correspondent residuals of the COINTREG estimation for a long-run relationship of the three time series. The residuals do seem to have a unit-root and not be a white-noise process, The Engle-Granger test performed on the data confirms that finding as it cannot reject the null hypothesis of the three time series not being cointegrated with a P-value of 0,995. Thus, we do not believe having a joint long-term relationship between the three variables. To confirm the finding we perform a Johansen cointegration test between the three series and get a similar result as we cannot reject the null of None’ cointegration relationships between the three in any direction with a P-value of 0.L11. Economically, this finding states that — at least on a statistical level ~ there is no long-run relationship between UK and France and Swiss GDP in the examined time period. 5.3 Simple conditional Model We now construct a conditional model consisting of past values of the dependent variable, current and possibly past values of the explanatory variables and according to our prior finding without ineluding an ECM term. AY, = a + BiAYeoa + BAX + ByAXoe + & Equiation 3. Multivariate conditional model To estimate the correct lag length to be inchided in the model we perform an automatic lag determination procedure, which sclects the ‘best’ model by AIC or SIC criteria, Both information criteria lead to a model without any lagged independent variables. The chosen model performs well on misspecification tests, as it removes nearly all autocorrelation in the correlogram (Figure 9), which gets confirmed by applying the LM test for serial correlation. resulting a P-value of 0.697, thus we cannot reject the null hypothesis of no autocorrelation We can also see normal distributed outliers (P-value 0.340) and no heteroscedasticity (P-value 80.380). The RESET-test confirms the finding with a P-value of 0.647, thus we cannot reject the null of no misspecification. According to our findings we achieve good performance in the aforementioned. misspecification tests with a relatively simple model. This is in line with our parsimony approach to achieve good forecasting performance with a relatively simple model paired with preferably low costs and computation effort. 5.4 Conditional model forecast To perform forecasts on the conditional model we will also implement forecasted values for the independent variables generated through the respective univariate models for France and UK GDP growth from section 4.5. We receive RMSE values for the static forecast of 473,33 and 574.08 for the dynamic ‘method. These errors are noticeably higher than the ones of the univariate model, 6 Multivariate VAR model 6.1 Estimation of VAR models To better incorporate the explanatory variables chosen to forecast Swiss GDP we will estimate a VAR model, which, differently from the simple conditional model, treats all variables equally and forecasts them simultaneousely. We will estimate a VAR that incorporates all data-scts, namely the GDP of Switzerland (Y), the GDP of France (X,) and the United Kingdom (X,). The fi step of correctly specifying a VAR model is the correct determination of the number of lags. According to the automatic lag determination that chooses models by information critetia, a model with one lag is sufficient. Since in a VAR(1) model there is still a significant amount of autocorrelation left, we decided to choose a two-lag model to achieve better performance in removing autocorrelation, The resulting VAR(2) performs very well on the correlogram (Figure 10). We also test the resulting VAR-model for misspeci ition. The null hypothesis of no serial correlation cannot be rejected using the LM-test with a P-value of 0.67. We do however, reject the null hypothesis of no heteroscedasticity. Additionally, on a 5% confidence level we cannot reject the null hypothesis of normal distributed residuals (P-value of 0.097).Ye = (AY AX ep Xa, 0)! AY = ce a AY Fa 2AK 2 Fa AK + WAX 2 $y DKe ea + MagAXne2 + Ere Dae = ea + a Mea + AyD ag + ayaa Fa AN 2 H y5AXy 4 + O6AXo,c-2 + Ere BNge = s+ ay, DYey + aypAVe 2 + dysAKi eo + ON t ysAXz¢-4 + OypAXp cn2 + Ese Equiation 4, VAR(2) approach forthe trivariate case 6.2 Granger causality Analog to identifying a long-term relationship by testing for cointegration we will now examine the dataset for short-term rel nships by performing tests to identify Granger causal relationships in the datasets. The identified Granger-causal relationships are displayed in Table 2. We find that Switzerland’s GDP growth Granger-causes French GDP growth on a 5% significance level. The United Kingdom’s GDP growth Granger-causes both Swiss and French GDP growth on a 10% and 5% significance level, respectively Our findings support the hypothesis that the proposedly more dynamic "first-mover” anglo- saxon economy can be used to forecast the central European countries’ economic activity, 6.3. Impulse responses To further examine short-run interdependencies and ‘causal’ relationships between the variables in the VAR we plot impulse responses of the three time series. The impulse response function traces the effect of an exogenous shock of one variable and its effect on all others. We tested for correlation in the residuals of the VAR and see a positive correlation of the respective res luals. To avoid a bias of correlated residuals we use Cholesky decomposed impulse responses and try go abstract economic relationships from the computed impulse responses. Firstly, itis clearly vi le that the growth of Swiss GDP reacts positively to a shoc! British GDP for periods of lag two, three and four. The same is true for the growth rate of French GDP and thus could confirm our hypothesis of an earlier response of UK GDP to 10global trends what could then be used to forecast French and Swiss GDP. Additionally, we can detect a more immediate response of the growth rate of Swiss GDP to a shock in BU (French) GDP growth, where we see significant impulses for the first two lags. The findings also support the discovered Granger-causal relationships found in 5.2, namely the significant relationship of the UK towards both France and Switzerland. 6.4 VAR forecasting As we also perform forecasts using the VAR-model we receive RMSE-values for the static model of 356.65 and for the dynamic model 452.76. The errors are lower than both the univariate and conditional model's forecast, whether the differences in performance are statistically significant will be evaluated in section 7. 7 Forecast comparison Finally, we will evaluate the forecasting performance off all models outlined. Figures 12 and 13 show alll forecasts and compare them to the true outcome of Swiss GDP accompanied by ‘Table 3 which presents all forecasts with RMSE for both static and dynamic models. Accordingly, the forecast with the lowest RMSE value for both static and dynamic forecasts is clearly the VAR-approach. We will still compare it to the other forecasts through a test and addi nally add a combination of the VAR and univariate model. ‘Through averaging with weights gained through a regression on the real values we receive two datasets of combined forecasts, For the dynamic approach we gain weights w, of 0.86 for the univariate model and 0.14 for the VAR model, Analog we get static weights for the static approach with 0.84 for the univariate and 0.16 for the VAR model. We run the Diebold-Mariano test as a regression of the forecasting differences on a constant using HAC standard errors. The results of this test are ible in Table 4, which states the correspondent t-stati ic and P-value under the null hypothesis that the two forecasts are identical. For the dynamic forecasts the VAR approach alone still delivers better performance than the VAR combined with the univariate model. The Diebold-Mariano test confirms a significant difference between the two. However, no such significant difference can be found for the static combined against the static univariate forecasts. Since the RMSE are also comparable, we must assume they are identical,8 Conlusion In our work we specified a univariate, multivariate conditional and a VAR model to exeeute various tests on the given time series and eventually evaluate the forecasting performance of the respective models as well as a combined forecasting approach. We started off with a correlati little about how the economies are connected with one another. We then tested for a long-run matrix between the three growth rates that tells us relatively relationship between the three countries and rejected such hypothesis. However, we did find short-run Granger-causal relationships that showed how the UK Granger-causes both France and Switzerland. We conducted a finer examination of this issue as we plotted impulse responses which uncovered how the UK influences both the EU (France) and Switzerland after a certain time lag. For forecasting purposes this relationship proved to be useful as the two-lag VAR-model showed the best dynamic forecasting performance and is, supported by Diebold-Mariano tests, signi Si be differentiated from the combined forecast. Since the univariate model can be estimated mntly better than the other forecasting methods. 1, the simple univariate model shows a good performance, in the static ease it even cannot with relatively low costs and computing power we want to highlight that it performed extraordinary well. As for the economic interpretation of these findings we can conclude that-with all the aforementioned limitations present— there exist short- and medium-run interdependen: between both the EU, proxied through France, and Switzerland as well as the UK and Sei etland in economic performance. Finally, the employed software package Eviews proved to be well suited for this type of research as it implements almost all tests and procedures natively. 129° Appendix 9.1 Graphs: 2 ot o 02 Figure 2. Line plot of S 6 bs ‘30 'o2 ‘od “os “os Oo Od Od Oe Of WO 12 14 — France GOP log — Swizerland GOP log — UK GP fog) Figure 1. Line plot of data sample from 1985 (QU) to 2014 (4) ‘Switzeriand GDP growth rate Hath! i Fe ‘oe bet “oo! “oe! “od Ge Ge 0 0d “od Oo oo WO 2 erland GDP growth rates from 1985 (QI) to 2014 (Qa)oll IM bia ch - |} “th oo es oo ad ode Be oo ad bv be be Wd Figure 3, Line plot of French and British GDP growth rates from 1985 (Q1) to 2014 (Q4) apne nite OLOGEUIT, Ee nar tc 9 Sie eesti ance oan carla any oe Ato i ae) ‘esd Gost —Gtesar como ‘iinagoe Shir Seow esti cn Figure 4. Eviews output of univariate model Sample: 198501 201108 Ines obsenatons: 107 Ost bor. or” aaasa 5 c003 ‘ono? oaded 6 2006 ona ons 1-404 008. 124 8402” 0s 1271 3 0008 ocor 42472 Doss oasy tera 003. dott 403 Oxo. ot. dane 01a. 043. 526596 208. “008” ses 006i 005i seme oro oa? 72652 Figure 5. Cortelogeamm of univariate model 1402 03 08 04 00 03 6688 9092 84 a6 8 00 02 ad Residual —— Actual —— Fitted 08 Figure 6. Residuals of univariate AR(1) estimation 810 = tr a ~08: 6 ‘aa ‘so ‘G2 “ow oe on bo wo od 08 08 — Residual — Actual — Fitea 10 "2 4 Figure 7. Residuals of multivariate COINTREG estimation 15Dependent Vr: (LOGS) Motes lest Squses Sara acted) 190509 209104 Ince abeeritins 106 ator aahsiens ts etrstedari conten dan ore & cove vrata Coticenk Si Ener _ataie Pros DiLesiswT:1y) _oaa01"e —ogreeae — geToars oame DLOGIUK)” —Daaeaes —aeesTY | aaTPOTe 040 DILOGR) §——oaraano—xeBez0 3457059 OUD e Doma dovorie aaa ovat Feauares 443088 Moen dopandener C008 Aajotes R-squorad 042885 SD eepencent vat tots 82 otrageeuon 04806. Akio rite ‘76n0 Sumsqisedwas Duets Semen aren ‘tee? tg etn SISE907 Harman Qunnertor “7 T2Pt Festa 2708513. uronic stat 2azosrs Prob tlie) oo0000. wa tate 2ieeo3 Provalésbste) ono Figure 8, Eviews output of multivariate mode! Dow: 10/476 Time: 20:02 Sample: 198501 201104 Incas cbseratons: 108 2justod fo 3 dynamicregressors PettalCoreiaton AZ PAC _OSut Prob 1 -001..001., 00373 9847 ‘0078 0079 07200 98606 0077 0049 13908, 00:1 0009 14083, 0033 0022 15319 0.4143 0139 33873, 0.012 oot 39045, 201...004.. 3.9387 0.20 0099 50307 002, 001.. $5861 1048 1-000. 902. 538883. 0.890, 1 "0033 ‘0002 sia4s 0.925 1--018.,-0.43.. 8.0250 caee fi 0060 0085 s47s7 (a6) 0166 0.170 11930 cae 0078 0101 12696 6605, “Probabilites maynotbe valor his ecuaton specication Figure 9. Comelogramm of multivariate modelFigure 11. VAR impulse response plot120,000. 118,000 116,000. 114,000 112,000 10,000) 108,000 106,000 104,000 Cw ee a ‘Unieviate (@ynamic) Muttsaiteeyramic} — VAR tayeamie} — switeerand — Combination namie) Figure 12. Graph of out-of-sample forecast and comparison of dynamic models 129,000 ‘18,000 116.00. 114,000 112,000 110,000 4 108,000 / 100,000.) 104,000. Meow wae we 208 2010 aot ota ate = Canbinaionsetatie) —— sutzetand — VaR Gato) Mutivariate ratios Unie statiy Figure 15, Graph of out-of-sample forecast and comparison of static models 189.2 Tables UK Switzerland Netherlands _ Germs France FU28 UK 1,000 0590 0.568 ssi 0.556 o.r26 Switwrland 0540 L000) 0.560 sae 0.036 0.678 Netherlands 056i 0.569 1.000, 0.622 0.730 0.792 Germany 0.551 0.588 0.622 1.000 0.758 ass Krance 0.656) 0.696 (030 0.365 L000 2.900 E28 0.726 0.678 0.792 0.385 0900 1.000 GDP growth rate with selected EU states and EL28 ‘Table 1. Correlation matrix of S Franoape | _— 708" [swirind ODP re |e eee 2 ‘Table 2, Granger causal relationships between GDP growth rates (chi-sq-statistic,* significant on 10% level, ** significant on 5% level) "RMSE dynamic "Univariate Multivariate VAR 452.76 Comb (least sq) «778.15 Table 3, Overview of RMSE of all forecasting models Diebold-Mariano-Test stat Prob —_ dynamic —_ - Univariate vs. Multivariate 162i 0.00 -— Combys. VARS BUDS "Comb vs. Multivariate 1332S. ‘Comb vs. Univariate “8.01 0.00, — static — Univariate vs, Multivariate 3.18 000 ~— Combys. VARS OST ~ Comb vs. Multivariate 338 000 ‘Comb vs. Univariate -038 OST ‘Table 4. Forecasting comparison using Diebold-Mariano tess 1910 Data Sources European Union: curostat Statistical Service. National Accounts. (2016). Gross Domestic Product of selected EU member states and accociates. Retrieved from: hupi//ec.europa.cu/eurostat/data/database 2011 Bibliography Diebold, F. X. (2015). Forecasting in Economics, Business, Finance and Beyond. University of Pennsylvania, Wooldridge, J. M. (2013). Introductory econometrics a modern approach (5. ed.). Mason, Ohio u.a.: South-Westem Cengage Learning, 21