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Let $z_{t}$ be stationary ARMA(p,q) (not ARIMA!) process. What would be the distribution of differencing of $z_{t}$? I mean the process $y_{t} = z_{t} - z_{t-1}$.

My attempt:

Let $z_{t}$ be stationary AR(1) process, i.e. $$ z_{t} = c + \phi z_{t-1} + \varepsilon_{t}, $$ with $|\phi| < 1$ and $\varepsilon_{t} \sim \mathcal{N}(0, \sigma^{2})$ i.i.d.

Then, let us define the differencing process by $y_{t} = z_{t} - z_{t-1}$. Clearly, it feels that it is wrong to say that $$ y_{t} = \phi y_{t-1} + \tilde{\varepsilon}_{t}, $$ because the AR(1) model is $$ z_{t}|z_{t-1}, z_{t-2}, \dots = z_{t}|z_{t-1} = c + \phi z_{t-1} + \varepsilon_{t}, $$ it is conditional distribution.

From the simulation below, one can see that the estimated covariance of differenced process and its lag 1 is far from $\phi$.

Python code for simulation:

import numpy as np
import scipy as sp
import statsmodels.api as sm

"""
function for simulation of AR(1)
"""
def simulate_z(nSample, phi, sigma_e, fVal, c):
    noise_e = sp.random.normal(0, sigma_e, nSample)
    z = np.zeros(nSample)
    z[0] = fVal
    for period in range(1, nSample):
        z[period] = c + phi * z[(period - 1)] + noise_e[period]
    return z

"""
OLS estimation
"""
def est_c_ph(z):
    x = z[0:-1]
    y = z[1:]
    p = sp.polyfit(x, y, 1)
    # Estimate phi
    phi_est = p[0]
    # Estimate c
    c_est = sp.mean(z) * (1 - phi_est)
    return [c_est, phi_est]

"""
values of the parameters for simulation
"""
phi = 0.95  # slope
c = 0.5  # intercept
sigma_e = 0.08  # standard deviation of observation noise
nSample = 500  # sample size
E = c / (1 - phi)  # mean value
fVal = E  # first value of the simulated process
"""
simulation of AR(1)
"""
z = simulate_z(nSample, phi, sigma_e, fVal, c)

c_est, phi_est = est_c_ph(z)
print("OLS [c, phi]: ", [c_est, phi_est])

"""
differencing of AR(1)
"""
z_dif = z[1:] - z[0:-1]

c_d_est, phi_d_est = est_c_ph(z_dif)
print("diff z OLS [c, phi]: ", [c_d_est, phi_d_est])
```
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Given $$ z_{t} = c + \phi z_{t-1} + \varepsilon_{t}, $$ lag both sides by 1 to obtain $$ z_{t-1} = c + \phi z_{t-2} + \varepsilon_{t-1}. $$

Subtract the second equation from the first one to get $$ \Delta z_{t} = \phi \Delta z_{t-1} + \varepsilon_{t} - \varepsilon_{t-1}. $$

With respect to $\Delta z_{t}$, this is ARMA(1,1) with AR1 coefficient $\phi$ and MA1 coefficient $-1$.

If you estimate AR(1) instead of ARMA(1,1), it should not be surprising that you will not recover $\phi$ but only a pseudo-true value which yields the best approximation to ARMA(1,1) by AR(1). This is also a good illustration of the problem of overdifferencing: you get a unit root in the MA part of the model.

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  • $\begingroup$ Dear Richard Hardy, about overdifferensing, well, assume we have ARMA with seasonal effect.Then, differencing would remome seasonality, but the differenced process will have a unit root in the MA part... $\endgroup$ – ABK Nov 15 '19 at 12:43
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    $\begingroup$ @ABK, differencing should be used for dealing with unit roots. Seasonal differencing is for seasonal unit roots. When used in other circumstances, differencing leads to a unit root MA process which is not unproblematic. Deterministic trends and deterministic seasonality can be dealt with using additional regressors. Seasonal AR and MA components in a SARIMA model can be used for dealing with stochastic seasonality. $\endgroup$ – Richard Hardy Nov 15 '19 at 13:04
  • $\begingroup$ Hi @RichardHardy, thanks for posting great content. I am starting my journey with VAR/VECM models. When you have some time, I would appreciate if you could give me a hand. Thank you. stats.stackexchange.com/questions/436077/… $\endgroup$ – Jordan Wrong Nov 15 '19 at 21:06
  • $\begingroup$ Dear @Jordan Wrong, the link in your comment is to this page, so I think it is wrong. $\endgroup$ – ABK Nov 16 '19 at 19:06
  • $\begingroup$ Thanks @ABK here is the new link. You might find it of interest! stats.stackexchange.com/questions/436302/… $\endgroup$ – Jordan Wrong Nov 16 '19 at 19:16

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