ECOM122 Applied Finance with Eviews Solution
Solutions:
a)
Ans:
From the above graph it is clear JPCPI is stable but USCPI is progressive.
b)
Ans:
st = log(jpyusd)
pt = log(jpcpi)
ptstar = log(uscpi)
qt = st + ptstar – pt
qt has increasing nature.
c)
The definition of random walk given so far is the most restricted one (RW1).The main difference between RW and martingale lies in the fact that the random walk process is more restrictive than the martingale in that it requires that the value following the first (e.g. the variance) be statistically independent.
Random walk hypothesis for the log-differenced.The tests we use are variance ratio test The variance ratio test is calculated optimal data-dependent methods. when longer-horizon data are used, there is more evidence of serial correlations in the log-differenced real exchange rates.
d) The purchasing power parity exchange rate is the rate between the two currencies as it is given in our case between the US currencies and japan currencies. In this case it would equate the two relevant national price levels if expressed in the common currency at that rate. Due to this the purchasing power of a unit of one currency would be the same in both economies. If the nominal exchange rate is defined simply as the price of one currency in terms of another, then the real exchange rate is the nominal exchange rate adjusted for relative national level differences. The central critique of the PPP hypothesis stems from this observation that the nominal exchange rate does not move in line with movements in the aggregate price ratios between countries. one source of this failure might be at the micro-level, due to persistent deviations from the law of one price from its different averages. The order of integration of the real exchange rate and its different averages.
e) Frenkel is one of the who first studies to test the behaviour of exchange rates in the post- bretton period. To test the hypothesis of purchasing power parity he ahs given to estimate the equation. In this we have to given the value of alpha is equal to 1. The equilibrium level of the real exchange rate and or the base years of the price indices used. In this hypothesis testing we have found that Us dollar are generally very poor, with insignificant or incorrectly signed coefficients. Results involving the US dollar are better.
f) To calculate this we have first taken the difference between the pt and pt* and we have stored it in the variable diffpt. Then we have cointegrated the st and diffpt using the Johannsen cointegration test. The results are as follows:
g) A vector error correction (VEC) model is a restricted VAR designed for use with nonstationary series that are known to be cointegrated. You may test for cointegration using an estimated VAR object, Equation object estimated using nonstationary regression methods, or using a Group object.
The VEC has cointegration relations built into the specification so that it restricts the long-run behaviour of the endogenous variables to converge to their cointegrating relationships while allowing for short-run adjustment dynamics. The cointegration term is known as the error correction term since the deviation from long-run equilibrium is corrected gradually through a series of partial short-run adjustments. The result of the error correction model is as follows:
