Master of Philosophy (M.

Phil) in Economics(Session 2010-11)

Term Paper Basic Econometrics-REC 003

GDP Forecast - Univariate Time Series (BOX-JENKINS Methodology and ARIMA Forecast Model)

Submitted by:

Mandeep Kumar Enrollment No.: 100165602

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Univariate Time Series Analysis

FORECAST FOR US GDP (1992 1ST QUARTER) AND INDIAN GDP (YEAR 2005-06) TIME SERIES: BOXJENKINS METHODOLOGY AND ARIMA FORECAST MODEL
INTRODUCTION:
Time series data are always been challenge for econometricians and practitioners. purpose of study of econometrics is not only to analysis the data but to forecast also. This term paper is based on econometric analysis of time series. Generally, a time series is a sequence of values a specific variable has taken on over some period of time. The observations have a natural ordering in time. Usually when we refer to a series of observation as time series, we assume some regularity of observation frequency. For example, one value is available for each year e.g. annual GDP; the observation frequency could be more often than yearly. For instance observation may be available for each quarter, each month or even each day of
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particular period. Nowadays, time series of stock prices or other financial market variables are even available at a much higher frequency such as every minute or seconds. Many economic problems can be analysed using time series data. Forecasting the future economic condition is one important objective of many analysis. For example, the Government may wish to know the tax revenue for the next quarter or year, investors may be interested in production or income of next year. In that case the forecast of the specific variable is desired. GDP is a perfect example of Time Series data, to analysis and to forecast. In this paper I have taken time series data of annual GDP, India for the period 1952 to 2005 and forecast for year 2006 is made. In first part I have taken US GDP quarterly data for the period 1970 to 1991, from the text book "Basic Econometrics" by Damodar N. Gujrati and Sangeeta, Fourth Edition for analysis and forecast of GDP for first quarter of 1992.

I used Box-Jenkins (BJ) methodology for forecasting the GDP, this methodology technically known as ARIMA methodology, the emphasis of this method analyzing the probabilistic, or stochastic nature of economic time series on their own under the philosophy let the data speak for themselves. The objective of Box-Jenkins is to identify and estimate a statistical model which can be interpreted as having generated the sample data. If this estimated model is then to be used for forecasting, we must assume that the features of his model are constant through time, and particularly over future time periods. Thus the simple reason for requiring stationary data is that any model which is inferred from these data can itself be interpreted as stationary or stable, therefore providing valid basis for forecasting.

BOX-JENKINS METHODOLOGY
1. MODEL IDENTIFICATION - TEST OF STATIONARITY:
I have used (A) Graphical analysis, (B) Auto correlation Function and Correlogram and (C) Augmented Dickey Fuller Test to test stationarity of time series data of GDP, US.

A. Graphical Analysis:
Characteristics of the time series can seen from the plot of the series, US GDP. Such a plot gives an initial clues about the likely nature of the time series data.
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The plot of the time series, US GDP

GDP
5,200

4,800

4,400

4,000

3,600

3,200

2,800 70 72 74 76 78 80 82 84 86 88 90

Figure-1: GDP, United States, 1970-1991 (Quarterly)

Over the period of study US GDP has been increasing, that is, showing upward trend, suggesting that the mean of US GDP has been changing. This suggests that the GDP series are not stationary.

B. AUTOCORRELATION FUNCTION (ACF), PARTIAL AUTOCORRELATIO FUNCTION(PACF) AND CORRELOGRAM:

Date: 08/16/11 Time: 18:26 Sample: 1970Q1 1991Q4 Included observations: 88 Autocorrelation Partial Correlation
. |******* . |******* . |******| . |******| . |******* .|. | .|. | .|. | 1 2 3 4

AC
0.969

PAC Q-Stat Prob

0.969 85.462 166.02 241.72 312.39 0.000 0.000 0.000 0.000

0.935 -0.058 0.901 -0.020 0.866 -0.045

. |******| . |******| . |***** | . |***** | . |***** | . |***** | . |**** | . |**** | . |**** | . |**** | . |*** | . |*** | . |*** | . |*** | . |** | . |** | . |** | . |** | . |** | . |*. | . |*. |

.|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .*| . | .|. | .|. | .|. | .|. |

5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

0.830 -0.024 0.791 -0.062 0.752 -0.029 0.713 -0.024 0.675 0.009

378.10 438.57 493.85 544.11 589.77 631.12 668.33 701.65 731.56 758.29 782.02 803.03 821.35 837.24 850.79 862.17 871.39 878.65 884.22 888.31 891.25

0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

0.638 -0.010 0.601 -0.020 0.565 -0.012 0.532 0.020

0.500 -0.012 0.468 -0.021 0.437 -0.001 0.405 -0.041 0.375 -0.005 0.344 -0.038 0.313 -0.017 0.279 -0.066 0.246 -0.019 0.214 -0.008 0.182 -0.018 0.153 0.017

Figure-2: Correlogram of U.S. GDP, 1970-I to 1991-IV. AC= autocorrelation, PAC= partial autocorrelation, Q-stat= Q Statistics, Prob= Probability.

The Correlogram and partial Correlogram of the US GDP series, up to 25 lags is shown in Figure-2. The autocorrelation coefficient (ACF) starts at a very high at lag 1 (0.969) and decline slowly; ACF up to 23 lags are individually statistically different from zero, for they all are outside the 95% confidence bounds. PACF drops dramatically after the first lag, and all PACFs after lag 1 are statistically insignificant. This leading us to conclusion that time series is non-stationary; It may be nonstationary in mean or variance or both.

C. AUGMENTED DICKEY-FULLER TEST- UNIT ROOT TEST:1. GDP is a Random Walk without drift:
Null Hypothesis: US, GDP has a unit root Exogenous: None Lag Length: 1 (Automatic - based on SIC, maxlag=11) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(GDP) Method: Least Squares Date: 08/16/11 Time: 18:28 Sample (adjusted): 1970Q3 1991Q4 Included observations: 86 after adjustments Variable GDP(-1) D(GDP(-1)) Coefficient 0.003899 0.327024 Std. Error 0.001130 0.103622 t-Statistic 3.449385 3.155918 Prob. 0.0009 0.0022 23.34535 35.93794 9.943242 10.00032 9.966214 3.449385 -2.592129 -1.944619 -1.614288 Prob.* 0.9998

R-squared 0.088841 Adjusted R-squared 0.077994 S.E. of regression 34.50803 Sum squared resid 100027.6 Log likelihood -425.5594 Durbin-Watson stat 2.034955

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter.

Random walk without drift, for US GDP. we rule out this model because the coefficient of GDPt-1, which is equal to is positive. But since =(-1), a positive would imply that > 1. We rule out this case because in this case the GDP time series would be explosive.

2. GDP is a Random Walk with drift:

Null Hypothesis: GDP has a unit root Exogenous: Constant Lag Length: 1 (Automatic - based on SIC, maxlag=20) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(GDP) Method: Least Squares Date: 08/16/11 Time: 18:31 Sample (adjusted): 1970Q3 1991Q4 Included observations: 86 after adjustments Variable GDP(-1) D(GDP(-1)) C Coefficient -0.003304 0.319711 28.71900 Std. Error t-Statistic Prob. 0.5857 0.0027 0.2281 23.34535 35.93794 9.948888 10.03451 9.983345 2.040544 -0.547205 -3.508326 -2.895512 -2.584952 Prob.* 0.8756

0.006038 -0.547205 0.103506 3.088807 23.65025 1.214321

R-squared 0.104746 Mean dependent var Adjusted R-squared 0.083173 S.D. dependent var S.E. of regression 34.41096 Akaike info criterion Sum squared resid 98281.49 Schwarz criterion Log likelihood -424.8022 Hannan-Quinn criter. F-statistic 4.855544 Durbin-Watson stat Prob(F-statistic) 0.010134

Random walk with drift, for US GDP. In this case the estimated coefficient of GDP t-1, which is equal to is negative, implying that the estimated value of is less than 1. For this model the estimated value is -0.547205 which in absolute value is below even the 10 percent critical value of -2.584952. Since in absolute terms, the estimated is smaller than critical value, our conclusion is that US GDP series is not stationary.

3. GDP is a Random Walk with drift and trend

Null Hypothesis: GDP has a unit root Exogenous: Constant, Linear Trend Lag Length: 1 (Automatic - based on SIC, maxlag=25) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(GDP) Method: Least Squares Date: 08/04/11 Time: 18:29 Sample (adjusted): 1970Q3 1991Q4 Included observations: 86 after adjustments Variable GDP(-1) D(GDP(-1)) C @TREND(1970Q1) Coefficient Std. Error -0.0786 0.3557 234.9729 1.8921 0.0355 0.1026 98.5876 0.8791 t-Statistic -2.2152 3.4647 2.3833 2.1522 Prob. 0.0295 0.0008 0.0194 0.0343 -2.2152 -4.0682 -3.4629 -3.1578 Prob.* 0.4749

S.E. of regression 33.6818 Akaike info criterion 9.9171 Sum squared resid 93026.3836 Schwarz criterion 10.0313 Log likelihood -422.4392 Hannan-Quinn criter. 9.9631 Durbin-Watson stat 2.0858

I have used augmented Dickey-Fuller (ADF) test with intercept and trend to test the stationarity and results are given above. The t (= ) value of the GDPt-1 coefficient ( = ) is -2.2152, but this value in absolute terms is much less than even the 10 percent critical value of -3.1570, again suggesting that even after taking care of possible autocorrelation in error term, the US GDP series is nonstationary.

First Differences of US, GDP series

First Difference of US GDP

120

80

40

-40

-80

-120 70 72 74 76 78 80 82 84 86 88 90 92

Figure-3: First Differences of US GDP, 1970 to 1991(quarterly)

To make US GDP series stationary, I have taken first differences of US GDP, using EVIEWs and plotted it on graph in figure-3. Unlike figure-1, I do not observe any trend in this series, perhaps suggesting that the first differenced US GDP time series is stationary. We can also see this visually from the estimated ACF and PACF correlograms given in figure-4.

AUGMENTED DICKEY-FULLER TEST of First Difference of US GDP series.

Null Hypothesis: DGDP has a unit root Exogenous: Constant Lag Length: 0 (Automatic - based on SIC, maxlag=11) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. -6.630339 -3.508326 -2.895512 -2.584952 Prob.* 0.0000

Augmented Dickey-Fuller Test Equation Dependent Variable: D(DGDP) Method: Least Squares Date: 08/19/11 Time: 23:38 Sample (adjusted): 1970Q3 1991Q4 Included observations: 86 after adjustments Variable DGDP(-1) C Coefficient -0.682762 16.00498 Std. Error t-Statistic Prob. 0.0000 0.0005 0.206977 42.04441 9.929234 9.986311 9.952205 2.034425

0.102975 -6.630339 4.396717 3.640211 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

R-squared 0.343552 Adjusted R-squared 0.335737 S.E. of regression 34.26717 Sum squared resid 98636.06 Log likelihood -424.9570 F-statistic 43.96140 Prob(F-statistic) 0.000000

First difference US GDP series is tested by Augmented Dickey-Fuller test. The t(= )value of the DGDPt-1 coefficient (=) is -6.630339,the value in absolute terms is more than even the 1 percent critical value of -3.508326, the first difference US GDP series is stationary.

Correlogram of First differences of US GDP:

Date: 08/16/11 Time: 18:27 Sample: 1970Q1 1991Q4 Included observations: 87 Autocorrelation Partial Correlation
. |** | . |*. | .|. | .|. | .|. | .|. | .*| . | **| . | .*| . | .|. | . |** | . |*. | .|. | .|. | .|. | .|. | .|. | **| . | . |*. | . |*. | 1 2 3 4

AC
0.316 0.186 0.051

PAC Q-Stat Prob

0.316 0.095 0.033 9.0136 12.165 12.389 12.631 12.636 12.672 13.188 21.380 21.820 21.855 0.003 0.002 0.006 0.013 0.027 0.049 0.068 0.006 0.009 0.016

0.049 -0.038

5 -0.007 -0.032 6 -0.019 -0.020 7 -0.073 -0.062 8 -0.289 -0.280 9 -0.067 10 0.019 0.128 0.100

.|. | **| . | .*| . | .*| . | .*| . | .|. | .|. | .|. | .|. | .|. | . |*. | .|. | .*| . | .|. | .|. |

.|. | **| . | .|. | .*| . | .|. | .|. | .|. | . |*. | .*| . | .*| . | . |*. | .|. | .*| . | .|. | . |*. |

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0.037 -0.008 0.011

21.991 27.892 29.314 33.712 35.474 35.610 35.956 35.965 36.195 36.694 37.519 37.696 38.259 38.384 38.406

0.024 0.006 0.006 0.002 0.002 0.003 0.005 0.007 0.010 0.013 0.015 0.020 0.024 0.032 0.042

12 -0.239 -0.311 13 -0.117 14 -0.204 -0.114 15 -0.128 -0.051 16 -0.035 -0.021 17 -0.056 -0.019 18 20 21 22 0.009 0.122 19 -0.045 -0.071 0.066 -0.126 0.084 0.089 0.039 -0.060

23 -0.068 -0.121 24 -0.032 -0.041 25 0.013 0.092

Figure-4: Correlogram of first differences of GDP, US, 1970-I to 1991-IV

The autocorrelations decline up to lag 4, the lags 1, 8 and 12 seem statistically different from zero; but all other lags are not statistically different from zero (the solid lines shown in his figure give the approximate 95% confidence limits). This is also true for partial autocorrelations. Let us therefore assume that the process that generated the (first differenced) GDP is at the most an AR(12) process. The Gujarati have included the only AR terms at lag 1, 8 and 12 which are significant.

2. ESTIMATION OF THE ARIMA MODEL:

MODEL AR(p) MA(q) ARMA(p,q)

ACF BEHAVIOR Decays Gradually Spikes in lag q Decays Gradually

PACF BEHAVIOR Spike in lag p Decays Gradually Decays Gradually

The above table is used to identify which kind of model we should be using AR, MA, or mixture model ARIMA. Given the fact that there can be multiple models that are likely candidates, I will use the (Schwartz Information Criterion) SIC statistics to choose the best one. The model with the smallest SIC value will be the better fit.
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A simple regression on the first difference of GDP to its lag value will serve as this error term. I have denoted the first differences of US GDP by DGDP. The tentative identified ARIMA (1,8,12;1;0) model is DGDP = + 1 AR(1) + 8 AR(8 ) + 12 AR(12). Using EViews, I obtained the following estimates:

Eviews code: dgdp c ar(1) ar(8) ar(12)

Dependent Variable: DGDP Method: Least Squares Date: 08/20/11 Time: 23:11 Sample (adjusted): 1973Q2 1991Q4 Included observations: 75 after adjustments Convergence achieved after 3 iterations Variable C AR(1) AR(8) AR(12) R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic) Inverted AR Roots Coefficient 23.08936 0.342768 -0.299466 -0.264371 0.293124 0.263256 31.38030 69915.33 -362.8286 9.813965 0.000017 .92-.28i .31+.87i -.57-.59i .92+.28i .31-.87i .61-.59i -.25+.88i .61+.59i -.25-.88i -.85-.28i Std. Error 2.980356 0.098794 t-Statistic 7.747181 3.469531 Prob. 0.0000 0.0009 0.0043 0.0091 21.52933 36.55936 9.782096 9.905695

0.101599 -2.947523 0.098582 -2.681742 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion

Hannan-Quinn criter. 9.831448 Durbin-Watson stat 1.766317

-.57+.59i -.85+.28i

As per Gujarati, other models are also checked with dependent veriable as AR(1) only, SIC=9.9863; with AR(1) and AR(8), SIC=9.9328; and with AR(8) and AR(12), SIC=10.0047, but on Schwarz Information Criterion (SIC) statistics this AR model found the best (minimum SIC=9.9056).
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I uesd the process of temporarily selecting several possible models with increasing order and simply choosing the one that optimizes the model selection statistics (AIC and SIC). Table 1 below summarizes the AIC (Akaike information criterion) and SIC (Schwarz criterion) results. The overall minimum SIC indicates an ARIMA(1,8,12;1;8) model; the coefficients are significant.

Model
ARMA(1,8,12;1) ARMA(1,8,12;8) ARMA(1,8,12;12) ARMA(1,8,12;8,12) ARMA(1,8,12;1,12)

SIC 9.92 9.6967 9.7047 9.7788 9.7098

AIC 9.76 9.5422 9.5502 9.5934 9.5244

Model MA(1) MA(8) MA(12) MA(1,12) MA(1,8,12)

SIC 10.0008 9.9463 9.9754 9.8121 9.7665

AIC 9.9513 9.8896 9.9187 9.7271 9.6531

Table-1. Search for the Best Model Akaike and Schwarz Criterion. On the basis of above table -1, I have choosen the ARIMA (1,8,12;1;8). I have denoted the first difference of US GDP by DGDP. The alternative to the model given in the book, is identified as ARIMA (1,8,12;1;8) model because the SIC and AIC is much less in this model i.e 9.6967 compared to 9.9056 choosen by Gujarati. The identified ARIMA (1,8,12;1;8) model is DGDP = + 1 AR(1) + 8 AR(8 ) + 12 AR(12) + 8 MA(8). Using EViews, I obtained the following estimates:

Eviews code: dgdp c ar(1) ar(8) ar(12) ma(8)

Dependent Variable: DGDP Method: Least Squares Date: 08/24/11 Time: 19:55 Sample (adjusted): 1973Q2 1991Q4 Included observations: 75 after adjustments Convergence achieved after 15 iterations MA Backcast: 1971Q2 1973Q1 Variable C AR(1) AR(8) AR(12) MA(8) R-squared Adjusted R-squared Coefficient 25.75666 0.244920 0.266051 -0.407692 -0.920604 0.458503 0.427560 Std. Error t-Statistic Prob. 0.0000 0.0060 0.0069 0.0001 0.0000 21.52933 36.55936 12

1.296402 19.86781 0.086407 2.834503 0.095613 2.782567 0.096015 -4.246119 0.023443 -39.26910 Mean dependent var S.D. dependent var

S.E. of regression Sum squared resid Log likelihood F-statistic Prob(F-statistic) Inverted AR Roots

27.66072 53558.09 -352.8342 14.81781 0.000000

Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat .91+.20i .71-.68i .22-.89i -.18+.88i -.66+.68i -.87+.20i .70-.70i .70+.70i -.70-.70i -.70-.70i

9.542244 9.696744 9.603934 1.612204 .71+.68i -.18-.88i -.87-.20i .00+.99i -.99

.91-.20i .22+.89i -.66-.68i Inverted MA Roots .99 -.00-.99i

3. DIGNOSTIC CHECKING:
To know that the model is fit to the data, Using EViews, I have obtained residuals from model and ACF and PACF of these residuals, up to 25 lags.

Correlogram of the residuals from ARIMA Model

Date: 08/19/11 Time: 19:28 Sample: 1973Q2 1991Q4 Included observations: 75 Q-statistic probabilities adjusted for 3 ARMA term(s) Autocorrelation . |*. . |*. .|. .*| . .|. .|. .|. .*| . . |*. . |*. . |*. .|. .|. .*| . **| . .|. .*| . .|. .|. | | | | | | | | | | | | | | | | | | | Partial Correlation . |*. . |*. .|. .*| . .|. .|. .|. .*| . . |*. . |*. . |*. .*| . .|. .*| . .*| . .|. .*| . .|. .|. | | | | | | | | | | | | | | | | | | | 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 AC 0.102 0.087 0.051 -0.104 -0.022 0.026 0.009 -0.082 0.132 0.132 0.118 -0.062 0.047 -0.160 -0.211 -0.013 -0.205 0.026 -0.002 PAC 0.102 0.077 0.035 -0.120 -0.008 0.047 0.016 -0.105 0.146 0.137 0.087 -0.157 0.069 -0.129 -0.185 -0.012 -0.138 0.072 -0.048 Q-Stat 0.8192 1.4151 1.6219 2.4963 2.5346 2.5919 2.5992 3.1735 4.6969 6.2497 7.5067 7.8561 8.0595 10.479 14.745 14.761 18.931 19.001 19.001 Prob

0.114 0.282 0.459 0.627 0.673 0.583 0.511 0.483 0.549 0.623 0.488 0.256 0.322 0.168 0.214 0.269 13

.*| . .|. .|. .*| . .*| . .*| .

| | | | | |

.*| . .|. .|. .*| . .|. .|.

| | | | | |

20 21 22 23 24 25

-0.107 0.036 -0.002 -0.073 -0.076 -0.084

-0.170 0.073 0.001 -0.074 -0.048 0.003

20.195 20.331 20.332 20.922 21.579 22.393

0.264 0.314 0.375 0.402 0.424 0.437

Figure-5: The correlogram of ACF and PACF of the residuals estimated from ARIMA model

The estimated ACF and PACF in correlogram given above shows, none of the autocorrelations and partial autocorrelations is individually statistically significant. The correlogram of both autocorrelation and partial autocorrelation give the impression that the residuals estimated from ARIMA model given above are purely random.

Graphical presentation of residuals:

120 80 40 0 -40 100 50 0 -50 -100 -150 70 72 74 76 78 Residual 80 82 Actual 84 86 Fitted 88 90 -80 -120

Figure-6: The graph of the residuals estimated from ARIMA model The errors of the model appear to be a white noise process, mean 0 and constant variance. The Augmented Dickey Fuller test rejects the hypothesis that the models error term is nonstationary. The diagnostic check of the models performance validates unbiased estimates and the SIC criteria mentioned above used to select the simple model ensures maximum efficiency is estimation.

4. FORECASTING GDP WITH THE MODEL SELECTED

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The US GDP data are for the period 1970Q1 to 1991Q4. On the basis of above model I would like to forecast the US GDP for the first quarter of 1992. In order to use the model that has been selected a mathematical formulation of the ARIMA (1,8,12;1;0) model must be outlines. After the model has been constructed using algebra the parameters estimated in this model above will be useful in building our forecasting model. Breaking down the lags and first differences yields the final forecasting model that will be used to forecast the GDP numbers. Thus, to obtain the forecast value of GDP (not DGDP) for 1992 Q1, Gujarati had rewriten the GDP1992Q1 - GDP1994Q4 = + 1 (GDP1991Q4 - GDP1991Q3) + 8 (GDP1989Q4 - GDP1989Q3) + 12 (GDP1988Q4 - GDP1988Q3) + u1992Q1 That is, GDP1992Q1 = + (1+1) GDP1991Q4 - 1 GDP1991Q3 + 8 GDP1989Q4 - 8 GDP1989Q3 + 12 GDP1988Q4 - 12 GDP1988Q3 + u1992Q1 GDP1992Q1 = 23.0893 + ((1+0.3428) X 4868) - 0.3428 X (4862.7) - 0.2994 X (4859.7) + 0.2994 X (4845.6) - 0.2644 X (4779.7) + 0.2644 X (4734.5) GDP1992Q1 = 4876.7 (Approx.) By model given by Gujarati Alternative Model Now, to obtain the Forecast value of the GDP for 1992Q1, by alternative model ARIMA(1,8,12;1;8) I have rewrite the model as GDP1992Q1 - GDP1994Q4 = + 1 (GDP1991Q4 - GDP1991Q3) + 8 (GDP1989Q4 - GDP1989Q3) + 12 (GDP1988Q4 - GDP1988Q3) + 8 (Resid1989Q4 - Resid1989Q3) + u1992Q1 that is, GDP1992Q1 = + (1+1) GDP1991Q4 - 1 GDP1991Q3 + 8 GDP1989Q4 - 8 GDP1989Q3 + 12 GDP1988Q4 - 12 GDP1988Q3 + 8 (Resid1989Q4 + Resid1989Q3)/2 + u1992Q1 GDP1992Q1 = 25.75666 + ((1+0.24492) X 4868) - 0.24492 X (4862.7) + 0.266051 X (4859.7) 0.266051 X (4845.6) - 0.407692 X (4779.7) + 0.407692 X (4734.5) -0.920604 X (11.012713.1513)/2 GDP1992Q1 = 4873.865 (Approx.) The actual value of GDP, US for 1992 Q1 was 4873.7 billion; the forecast error was an overestimate of 3 billion by model given in Gujarati whereas the alternative model given in this paper have an overestimate of 0.16 billion. Tha forecast by alternative model is more close to actual value,

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120

80

40

-40

-80

-120 70 72 74 76 78 80 DGDP 82 84 DGDPF 86 88 90 92

Figure-7 : forecast series of DGDP for the period 1973Q2 to 1992Q1.

150

100

50

-50

Forecast: DGDPF Actual: DGDP Forecast sample: 1970Q1 1992Q4 Adjusted sample: 1973Q2 1992Q1 Included observations: 75 Root Mean Squared Error 30.53202 Mean Absolute Error 23.43041 Mean Abs. Percent Error 151.7918 Theil Inequality Coefficient 0.427781 Bias Proportion 0.000000 Variance Proportion 0.297514 Covariance Proportion 0.702486

-100 1974 1976 1978 1980 1982 1984 1986 1988 1990

DGDPF

2 S.E.

Figure-8 : Static forecast of US GDP for the period 1973Q2 to 1992Q1.

To forecast a series of one step ahead, In Eviews I used the static forecast. The above figure8 shows the graph of US GDP static forecast and the plus and minus two standard error bands.

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160

120

80

40

-40

Forecast: DGDPF Actual: DGDP Forecast sample: 1970Q1 1992Q4 Adjusted sample: 1973Q2 1992Q4 Included observations: 75 Root Mean Squared Error 34.84953 Mean Absolute Error 25.96951 Mean Abs. Percent Error 165.4680 Theil Inequality Coefficient 0.522536 Bias Proportion 0.000819 Variance Proportion 0.588891 Covariance Proportion 0.410290

-80 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992

DGDPF

2 S.E.

Figure-9 : Dynamic forecast of US GDP for the period 1970Q1 to 1992Q4.

Using EViews, The above graph shows a dynamic forecast using the above mentioned ARIMA model over the sample period 1970Q1 to 1992Q4. The forecast values is placed in the series DGDPF, and EViews has produced a graph of the forecasts and the plus and minus two standard errors bands, as well as a forecast evaluation given in box right to graph.

17

INDIAN GDP Forecast for year 2006: Box-Jenkins Methodology and ARIMA Forecast Model
In this term paper, By using the Box-Jenkins methodology to fit an ARIMA forecast model to the time series of Indian GDP for the period 1952 to 2005, forecast for year 2005-06 is made and compared with actual value.

BOX-JENKINS METHODOLOGY 1) MODEL IDENTIFICATION - TEST OF STATIONARITY:

I will use (A) Graphical analysis, (B) Auto correlation Function and Correlogram and (C) Augmented Dickey -Fuller test to test stationarity of time series data of GDP, INDIA.

(A) Graphical Analysis:

Characteristics of the time series can seen from the plot of the series, INDIAN GDP. Such a plot gives an initial clues about the likely nature of the time series data.
GDP at Factor Cost
2,800,000 2,400,000 2,000,000 1,600,000 1,200,000 800,000 400,000 0 55 60 65 70 75 80 85 90 95 00 05

Figure10: GDP, India, 1952-2005(annually)

Over the period of study GDP of India has been increasing, that is, showing upward trend, suggesting that the mean of GDP has been changing. This suggests that the GDP series are not stationary. India's GDP growth was very low till 1990's, but after economic reforms it shows sufficient upward movement.
18

B. CORRELOGRAM AND PARTIAL CORRELOGRAM:

Date: 08/19/11 Time: 19:52 Sample: 1952 2005 Included observations: 54 Autocorrelation Partial Correlation
. |******* . |******| . |******| . |***** | . |***** | . |**** | . |**** | . |*** | . |*** | . |** | . |** | . |** | . |*. | . |*. | . |*. | . |*. | .|. | .|. | .|. | .|. | .|. | .*| . | .*| . | .*| . | .*| . | . |******* .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | .|. | 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

AC
0.915 0.768

PAC Q-Stat Prob

0.915 0.013 47.796 88.577 123.58 153.14 177.89 198.22 214.72 227.98 238.29 246.26 252.33 256.81 260.02 262.20 263.48 264.10 264.32 264.36 264.37 264.49 264.88 265.69 267.02 269.00 271.70 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

0.837 -0.002 0.699 -0.036 0.633 -0.017 0.568 -0.034 0.506 -0.018 0.449 -0.012 0.392 -0.034 0.341 -0.002 0.294 -0.009 0.250 -0.013 0.208 -0.015 0.170 -0.015 0.129 -0.048 0.089 -0.028 0.052 -0.017 0.021 0.002

19 -0.009 -0.023 20 -0.037 -0.020 21 -0.065 -0.027 22 -0.093 -0.031 23 -0.116 -0.010 24 -0.140 -0.031 25 -0.161 -0.012

Figure-11: Correlogram of GDP, India, 1951-52 to 2004-05. The Correlogram of the India's GDP time series, up to 25 lags is shown in Figure-11. The autocorrelation coefficient starts at a very high at lag 1 (0.915) and decline slowly, ACF up to 12 lags are individually statistically different from zero, for they all are outside the 95% confidence bounds. PACF drops dramatically after the first lag, and all PACFs after lag 1 are statistically insignificant. This leading us to conclusion that time series is non-stationary; It may be nonstationary in mean or variance or both.

19

C. AUGMENTED DICKEY -FULLER TEST: UNIT ROOT TEST

(i) RANDOM WALK WITH DRIFT Null Hypothesis: GDP has a unit root Exogenous: Constant Lag Length: 0 (Automatic - based on SIC, maxlag=10) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(GDP) Method: Least Squares Date: 08/14/11 Time: 19:55 Sample (adjusted): 1953 2005 Included observations: 53 after adjustments Variable GDP(-1) C Coefficient 0.068553 -13117.18 Std. Error t-Statistic Prob. 0.0000 0.0123 40730.83 42341.87 22.75300 22.82735 22.78159 2.308236 12.88656 -3.560019 -2.917650 -2.596689 Prob.* 1.0000

0.005320 12.88656 5056.136 -2.594308

R-squared 0.765046 Mean dependent var Adjusted R-squared 0.760439 S.D. dependent var S.E. of regression 20724.23 Akaike info criterion Sum squared resid 2.19E+10 Schwarz criterion Log likelihood -600.9545 Hannan-Quinn criter. F-statistic 166.0633 Durbin-Watson stat Prob(F-statistic) 0.000000

Random walk with drift, for India GDP. we rule out this model because the coefficient of GDPt-1, which is equal to is positive. But since =(-1), a positive would imply that > 1. We rule out this case because in this case the GDP time series would be explosive.

20

(ii) RANDOM WALK WITH DRIFT AND TREND Null Hypothesis: GDP has a unit root Exogenous: Constant, Linear Trend Lag Length: 0 (Automatic - based on SIC, maxlag=10) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(GDP) Method: Least Squares Date: 08/14/11 Time: 19:56 Sample (adjusted): 1953 2005 Included observations: 53 after adjustments Variable GDP(-1) C @TREND(1952) Coefficient 0.079422 -10530.35 -412.0081 Std. Error t-Statistic Prob. 0.0000 0.0810 0.3991 40730.83 42341.87 22.77637 22.88790 22.81926 2.364045 5.735573 -4.140858 -3.496960 -3.177579 Prob.* 1.0000

0.013847 5.735573 5912.168 -1.781132 484.4021 -0.850550

R-squared 0.768397 Mean dependent var Adjusted R-squared 0.759132 S.D. dependent var S.E. of regression 20780.65 Akaike info criterion Sum squared resid 2.16E+10 Schwarz criterion Log likelihood -600.5738 Hannan-Quinn criter. F-statistic 82.94312 Durbin-Watson stat Prob(F-statistic) 0.000000

Random walk with drift and trend, for India GDP. we rule out this model because the coefficient of GDPt-1, which is equal to is positive. But since =(-1), a positive would imply that > 1. We rule out this case because in this case the GDP time series would be explosive.

21

FIRST DIFFERENCE OF INDIAN GDP (i) Graphical Analysis of First differences of INDIAN GDP:
DGDP
200,000

160,000

120,000

80,000

40,000

-40,000 55 60 65 70 75 80 85 90 95 00 05

Figure-12 : First Difference of Indian GDP, for the period 1952 to 2005

The first defference of Indian GDP, over the period of study has been increasing, that is, showing upward trend, suggesting that the mean of GDP has been changing. This suggests that the First Difference of INDIAN GDP series is not stationary.

(ii) Correlogram and Partial Correlogram of First differences of INDIAN GDP:

Date: 08/20/11 Time: 22:24 Sample: 1952 2005 Included observations: 53 Autocorrelation Partial Correlation
. |***** | . |**** | . |**** | . |*** | . |**** | . |*** | . |*** | . |*** | . |** | . |** | . |** | . |*. | . |***** | . |** | . |** | .|. | . |** | .|. | .|. | .|. | .*| . | .*| . | .|. | .*| . | 1 2 3 4 5 6 7 8 9 10 11 12

AC
0.650 0.555 0.558 0.462 0.529 0.449 0.403 0.420 0.281 0.240 0.229 0.120

PAC Q-Stat Prob

0.650 0.230 0.238 -0.007 0.253 -0.058 0.032 0.036 -0.165 -0.086 -0.014 -0.142 23.680 41.310 59.449 72.125 89.113 101.64 111.92 123.33 128.55 132.45 136.09 137.11 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

22

. |*. . |*. . |*. .|. .|. .|. .|. .|. .|. .*| . .*| . .*| . .*| .

| | | | | | | | | | | | |

.|. .|. . |*. .*| . .|. .|. .|. .|. .|. .*| . .|. .*| . .|.

| | | | | | | | | | | | |

13 14 15 16 17 18 19 20 21 22 23 24 25

0.142 0.127 0.139 0.056 -0.022 -0.004 -0.030 -0.042 -0.045 -0.129 -0.112 -0.182 -0.203

0.022 0.046 0.139 -0.176 -0.014 0.004 -0.017 -0.018 0.010 -0.161 0.024 -0.129 0.024

138.57 139.78 141.27 141.51 141.55 141.55 141.63 141.79 141.97 143.53 144.75 148.09 152.39

0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

Figure-13 : The Correlogram of First Difference of Indian GDP, for the period 1952 to 2005

The Correlogram of the First Difference of India's GDP time series, up to 11 lags is shown in Figure-13. The autocorrelation coefficient starts at a high at lag 1 (0.650) and decline slowly, ACF up to 11 lags are individually statistically different from zero, for they all are outside the 95% confidence bounds. PACF drops dramatically after the third lag, and all PACFs after lag 5 are statistically insignificant. This leading us to conclusion that time series is non-stationary; It may be nonstationary in mean or variance or both.

C. AUGMENTED DICKEY -FULLER TEST of First Difference of Indian GDP: UNIT ROOT TEST
(i) RANDOM WALK WITH DRIFT
Null Hypothesis: DGDP has a unit root Exogenous: Constant Lag Length: 7 (Automatic - based on SIC, maxlag=10) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(DGDP) Method: Least Squares Date: 08/20/11 Time: 22:39 Sample (adjusted): 1961 2005 Included observations: 45 after adjustments 23 3.696256 -3.584743 -2.928142 -2.602225 Prob.* 1.0000

Variable DGDP(-1) D(DGDP(-1)) D(DGDP(-2)) D(DGDP(-3)) D(DGDP(-4)) D(DGDP(-5)) D(DGDP(-6)) D(DGDP(-7)) C S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat

Coefficient 0.544567 -1.628306 -1.663902 -1.524341 -1.532311 -1.203777 -0.901187 -0.505443 -587.9856 22433.22 1.81E+10 -509.6549 2.070199

Std. Error 0.147329 0.251825 0.318961 0.339006 0.322380 0.320796 0.274534 0.193925 5469.960

t-Statistic 3.696256 -6.466034 -5.216633 -4.496503 -4.753121 -3.752468 -3.282603 -2.606375 -0.107494

Prob. 0.0007 0.0000 0.0000 0.0001 0.0000 0.0006 0.0023 0.0132 0.9150

Akaike info criterion 23.05133 Schwarz criterion 23.41266 Hannan-Quinn criter. 23.18603

Random walk with drift and trend, for India GDP. we rule out this model because the coefficient of GDPt-1, which is equal to is positive. But since =(-1), a positive would imply that > 1. We rule out this case because in this case the GDP time series would be explosive.

SECOND DEFFERENCE OF INDIAN GDP

DDGDP
120,000

80,000

40,000

-40,000

-80,000 55 60 65 70 75 80 85 90 95 00 05

Figure-14 : Second difference of India GDP for the period 1952 to 2005

24

I have taken the second difference of Indian GDP, using EViews and plotted it on graph in figure-14. The graph shows that the second difference of Indian GDP series is stationary. We can also see this visually from the estimated ACF and PACF correlograms given below in figure-15 and Augmented Dickey-Fuller test given below, which shows that Indian GDP time series is stationary.

Augmented Dickey Fuller test of second difference of Indian GDP

(i) RANDOM WALK WITH DRIFT
Unit root with drift Null Hypothesis: DDGDP has a unit root Exogenous: Constant Lag Length: 1 (Automatic - based on SIC, maxlag=10) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(DDGDP) Method: Least Squares Date: 08/20/11 Time: 22:36 Sample (adjusted): 1956 2005 Included observations: 50 after adjustments Variable DDGDP(-1) D(DDGDP(-1)) C Coefficient -2.071391 0.363583 5875.982 Std. Error t-Statistic Prob. 0.0000 0.0263 0.1183 94.38000 54542.17 23.20905 23.32377 23.25274 1.962118 -7.796844 -3.568308 -2.921175 -2.598551 Prob.* 0.0000

0.265670 -7.796844 0.158469 2.294347 3692.866 1.591171 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

R-squared 0.786065 Adjusted R-squared 0.776961 S.E. of regression 25758.60 Sum squared resid 3.12E+10 Log likelihood -577.2262 F-statistic 86.34650 Prob(F-statistic) 0.000000

Second difference of INDIAN GDP series is tested by Augmented Dickey-Fuller test. The t (= ) value of the DGDPt-1 coefficient (=) is -7.796844, the value in absolute terms is more than even the 1 percent critical value of -3.568308, It shows that the second difference INDIAN GDP series is stationary.
25

(i) RANDOM WALK WITH DRIFT AND TREND

Null Hypothesis: DDGDP has a unit root Exogenous: Constant, Linear Trend Lag Length: 6 (Automatic - based on SIC, maxlag=10) t-Statistic Augmented Dickey-Fuller test statistic Test critical values: 1% level 5% level 10% level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(DDGDP) Method: Least Squares Date: 08/20/11 Time: 22:37 Sample (adjusted): 1961 2005 Included observations: 45 after adjustments Variable DDGDP(-1) D(DDGDP(-1)) D(DDGDP(-2)) D(DDGDP(-3)) D(DDGDP(-4)) D(DDGDP(-5)) D(DDGDP(-6)) C @TREND(1952) Coefficient -8.301953 6.163642 4.893284 3.669885 2.357670 1.304044 0.482988 -17869.72 1183.450 Std. Error t-Statistic Prob. 0.0000 0.0001 0.0001 0.0003 0.0012 0.0035 0.0146 0.0521 0.0004 137.8667 56695.84 23.02604 23.38737 23.16074 2.028125 -5.748257 -4.175640 -3.513075 -3.186854 Prob.* 0.0001

1.444256 -5.748257 1.338779 4.603927 1.142647 4.282409 0.905690 4.052030 0.670398 3.516823 0.417466 3.123710 0.188232 2.565919 8894.947 -2.008975 306.2348 3.864517 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

R-squared 0.875105 Adjusted R-squared 0.847350 S.E. of regression 22151.29 Sum squared resid 1.77E+10 Log likelihood -509.0858 F-statistic 31.53023 Prob(F-statistic) 0.000000

Second difference INDIAN GDP series is tested by Augmented Dickey-Fuller test. The t (= ) value of the DGDPt-1 coefficient (=) is -5.748257, the value in absolute terms is more than even the 1 percent critical value of -4.175640, It shows that the second difference INDIAN GDP series is stationary.

26

Correlogram of Second differences of INDIAN GDP:

Date: 08/20/11 Time: 22:35 Sample: 1952 2005 Included observations: 52 Autocorrelation Partial Correlation
****| . .|. . |*. **| . . |*. .|. .|. . |*. .*| . .|. . |** **| . . |*. .*| . . |*. .*| . .|. .|. .|. .|. . |*. .*| . . |*. .*| . | | | | | | | | | | | | | | | | | | | | | | | | ****| . **| . .|. **| . .*| . .|. .|. . |*. . |*. .*| . . |** . |*. . |*. .*| . . |*. .|. .|. .*| . .|. .*| . . |*. .*| . . |*. .|. | | | | | | | | | | | | | | | | | | | | | | | | 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

AC
-0.524 0.062 0.097 -0.237 0.185 -0.046 -0.033 0.185 -0.163 -0.024 0.227 -0.236 0.152 -0.147 0.186 -0.112 -0.022 0.063 -0.038 -0.021 0.101 -0.120 0.151 -0.149

PAC Q-Stat Prob

-0.524 -0.293 -0.022 -0.246 -0.094 -0.027 -0.034 0.173 0.097 -0.070 0.230 0.099 0.085 -0.144 0.205 -0.018 -0.059 -0.072 -0.035 -0.106 0.083 -0.106 0.106 -0.052 15.122 15.341 15.876 19.160 21.202 21.329 21.397 23.574 25.309 25.346 28.867 32.774 34.428 36.019 38.655 39.627 39.665 39.997 40.120 40.157 41.081 42.426 44.645 46.872 0.000 0.000 0.001 0.001 0.001 0.002 0.003 0.003 0.003 0.005 0.002 0.001 0.001 0.001 0.001 0.001 0.001 0.002 0.003 0.005 0.005 0.006 0.004 0.003

Figure-15: Correlogram of Second differences of GDP, India, 1952 to 2005 The autocorrelations at the lag 1 and 4 seem statistically different from zero; but all other lags are not statistically different from zero (the solid lines shown in this figure gives the approximate 95% confidence limits). The Partial Autocorrelations is also statistically different from zero at lag 1, 2 and 4. Let us therefore assume that the process that generated the (second differenced) GDP is at the most an ARIMA(4;2;4) process.

In practice, the identification of models can be difficult since the observed patterns of autocorrelations only roughly correspond to the theoretical patterns, or the assignment is ambiguous. However, analysts often circumvent this tricky process by temporarily selecting several possible models with increasing order and simply choosing the one that optimizes the model selection statistics (AIC and SIC). Table 1 below summarizes the AIC (Akaike information criterion) and SC (Schwarz criterion) results. The overall minimum SIC indicates an MA(1,4) model; the coefficients are significant.
27

model AR(1) AR(1,2) AR(4) ARMA(1,1)

SIC 23.3301 23.3237 23.64 23.2411

AIC 23.2543 23.209 23.56 23.1274 22.9930

Model MA(1) MA(1,4) MA(4)

SIC 23.1521 23.0499 23.5698

AIC 23.0771 22.93 23.4948 22.9605 23.5663

ARMA(1,4;1,4)23.1554 ARMA(4,4) 23.6833

ARMA(1;1,4) 23.1454

Table-1. Search for the Best Model Akaike and Schwarz Criterion. On the basis of above table -1, I have choosen the ARIMA model (0;2;1,4). I have denoted the second differences of INDIAN GDP by DDGDP. The tentative identified ARIMA (0;2;1,4) model is DDGDP = + 1 MA(1) + 4 MA(4 ). Using EViews, I obtained the following estimates:

Eviews code: ddgdp c ma(1) ma(4)

Dependent Variable: DDGDP Method: Least Squares Date: 08/20/11 Time: 23:28 Sample (adjusted): 1954 2005 Included observations: 52 after adjustments Convergence achieved after 44 iterations MA Backcast: 1950 1953 Variable C MA(1) MA(4) Coefficient 2643.353 -1.090621 0.341086 Std. Error t-Statistic Prob. 0.0016 0.0000 0.0000 3066.962 30652.08 22.93735 23.04992 22.98050 1.904553

792.4623 3.335620 0.035871 -30.40428 0.022874 14.91139 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion Hannan-Quinn criter. Durbin-Watson stat

R-squared 0.481808 Adjusted R-squared 0.460657 S.E. of regression 22510.88 Sum squared resid 2.48E+10 Log likelihood -593.3710 F-statistic 22.77974 Prob(F-statistic) 0.000000 Inverted MA Roots .90-.33i

.90+.33i

-.36+.49i

-.36-.49i

28

3. DIGNOSTIC CHECKING:
To know that the model is fit to the data, Using EViews, I have obtained residuals from model and ACF and PACF of these residuals, up to 25 lags.

Correlogram of the residuals from ARIMA Model

Date: 08/20/11 Time: 23:22 Sample: 1954 2005 Included observations: 52 Q-statistic probabilities adjusted for 2 ARMA term(s) Autocorrelation Partial Correlation .|. .|. . |*. .*| . . |** . |*. . |*. . |** .|. .|. . |*. .*| . . |*. .|. . |*. .|. .*| . .|. .|. .|. .|. .*| . .|. .*| . | | | | | | | | | | | | | | | | | | | | | | | | .|. .|. . |*. .*| . . |** . |*. . |*. . |** .|. .|. . |*. .*| . .*| . .*| . . |*. **| . .*| . .|. .|. .|. . |*. .*| . .|. .*| . | | | | | | | | | | | | | | | | | | | | | | | | AC PAC Q-Stat Prob 7.E-05 0.1700 2.2713 3.8693 7.2121 8.3849 8.8293 15.848 15.858 15.997 17.940 18.449 18.887 18.913 20.963 20.975 21.385 21.561 21.656 21.741 22.214 23.778 23.866 27.009

1 -0.001 -0.001 2 0.055 0.055 3 0.191 0.192 4 -0.165 -0.173 5 0.237 0.233 6 0.139 0.118 7 0.084 0.135 8 0.332 0.240 9 0.012 0.048 10 0.045 0.001 11 0.168 0.083 12 -0.085 -0.071 13 0.078 -0.077 14 0.019 -0.122 15 0.164 0.175 16 -0.012 -0.223 17 -0.071 -0.100 18 0.046 -0.047 19 -0.033 0.010 20 0.031 -0.017 21 0.072 0.085 22 -0.129 -0.132 23 0.030 0.008 24 -0.177 -0.176

0.132 0.144 0.065 0.078 0.116 0.015 0.026 0.042 0.036 0.048 0.063 0.091 0.074 0.102 0.125 0.158 0.198 0.244 0.274 0.252 0.300 0.211

Figure-16: The correlogram of ACF and PACF of the residuals estimated from ARIMA model

The estimated ACF and PACF in correlogram given above shows, none of the autocorrelations and partial autocorrelations is individually statistically significant. The correlogram of both autocorrelation and partial autocorrelation give the impression that the residuals estimated from ARIMA model given above are purely random.

29

Graphical presentation of residuals:

120,000 80,000 40,000 0 60,000 40,000 20,000 0 -20,000 -40,000 -60,000 55 60 65 70 75 80 85 90 Fitted 95 00 05 -80,000 -40,000

Residual

Actual

Figure-17: The graph of the residuals estimated from ARIMA model The errors of the model appear to be a white noise process, mean 0 and constant variance. The Augmented Dickey Fuller test rejects the hypothesis that the models error term is nonstationary. The diagnostic check of the models performance validates unbiased estimates and the SIC criteria mentioned above used to select the simple model ensures maximum efficiency is estimation.

4. FORECASTING GDP WITH THE MODEL SELECTED

The Indian GDP data are given for the period 1951-52 to 2004-05. On the basis of above model I would like to forecast the Indian GDP for the Year 2005-06. In order to use the model that has been selected a mathematical formulation of the ARIMA (0;2;1,4) model must be outlines. After the model has been constructed using algebra the parameters estimated in this model above will be useful in building our forecasting model. Breaking down the Moving averages of errors and second differences yields the final forecasting model that will be used to forecast the GDP numbers.

30

Thus, to obtain the forecast value of GDP (not DDGDP) for year 2006, I rewrite the above model as (GDP2006 - GDP2005) - (GDP2005 -GDP2004) = + u2006 + 1 ma1 + 2 ma4 That is, GDP2006 = + GDP2005 + GDP2005 - GDP2004 + 1 (RESID2005+ RESID2004)/2 + 2 (RESID2002 + RESID2001)/2 + u2006 GDP2006 = 2643.353 +2388768+2388768 - 2222758 + (- 1.090621 X (48417.7 - 50396.3) + 0.341086 X (13895.5 + 13368.5) GDP2006 = 2568879 (Approx.)

The actual value of GDP, INDIA for YEAR 2005-06 was 2604532 crores; the forecast error is an underestimate of 35653 crore. The growth of GDP in 2005-06 was 9.5, which was highest ever.

DDGDPF
80,000 60,000 40,000 20,000 0 -20,000 -40,000 -60,000 55 60 65 70 75 80 85 90 95 00 05

Figure-18 : forecast series of DDGDP for the period 1952 to 2006.

31

Static Forecast for year 2005-06.

120,000

80,000

40,000

-40,000

Forecast: DDGDPF Actual: DDGDP Forecast sample: 1952 2006 Included observations: 52 Root Mean Squared Error 21851.88 Mean Absolute Error 16619.87 Mean Abs. Percent Error 125.0190 Theil Inequality Coefficient 0.412259 Bias Proportion 0.000064 Variance Proportion 0.137265 Covariance Proportion 0.862671

-80,000

-120,000 55 60 65 70 75 DDGDPF 80 85 2 S.E. 90 95 00 05

Figure-8 : Static forecast of Second difference of INDIAN GDP for the period 1951-52 to 2005-06.

Static Forecast, is to forecast a one step ahead in time series. By using Eviews, I plotted the static forecast of second difference of GDP, India on graph. The above figure-8 shows the graph of second difference of INDIAN GDP static forecast for year 2006 and the plus and minus two standard error bands.

Dynamic Forecast of second difference of Indian GDP.

80,000 60,000 40,000 20,000 0 -20,000 -40,000 -60,000 -80,000 55 60 65 70 75 DDGDPF 80 85 2 S.E. 90 95 00 05

Forecast: DDGDPF Actual: DDGDP Forecast sample: 1952 2006 Included observations: 52 Root Mean Squared Error 30352.56 Mean Absolute Error 23067.56 Mean Abs. Percent Error 99.88171 Theil Inequality Coefficient 0.916579 Bias Proportion 0.000294 Variance Proportion 0.964536 Covariance Proportion 0.035170

Figure-9 : Dynamic forecast of second difference INDIAN GDP for the period 1951-52 to 2005-06.

Using EViews, The above graph shows a dynamic forecast using the above mentioned ARIMA model over the sample period 1952 to 2006. The forecast values is placed in the series DGDPF, and EViews has produced a graph of the forecasts and the plus and minus two standard errors bands, as well as a forecast evaluation given in box right to graph.

32

References: 1. Basic Econometrics, forth Edition, Damodar N. Gujarati and Sangeetha 2. Econometrics Methods, Forth Edition, J. Johnston and J. Dinardo 3. EViews user guides 4. Using EViews for Undergraduate Econometrics, Second edition, by R. Carter Hill, William E. Griffiths and George G. Judge 5. RBI, Databank for Indian GDP series 6. Planning Commision official website for data.

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