Lab: Box-Jenkins Methodology -

Test Data Set 1

In this lab we explore the Box-Jenkins methodology by applying it to a test time-
series data set comprising100 observations as set out in the worksheet Test data 1
worksheet (see chart below).

Time Series and Forecast

5.0

4.0

3.0

2.0

1.0

0.0
1

6
11

16
21

26

31

36
41

46

51

56

61
66

71
76

81
86

91
96
-1.0

-2.0

-3.0 Actual
-4.0 Forecast

In keeping with the principles of the Box-Jenkins method, the analysis will follow the
usual sequence, illustrated overleaf.
Ø The series is clearly stationary so we may go directly to the second part of Phase I,
model selection.
Ø Use only the last 98 observations to in the model building and testing phases.

1. Compute the ACF and PACF of the time series and use these to select from
amongst the available level I ARMA models ARMA(1,0), ARMA(1,1) and
ARMA(0,1).
2. Perform an analysis of variance for each model to compute the model and error
sums of squares and test the significance of each model.
3. Compute the Akaike Information Criterion (AIC) and and Bayes Information
Criterion (BIC) for each model and use these to estimate the model parameters
and determine the model which best fits the data.
It may help you to perform the analysis in the following way:

Model a-coefficent b-coefficient AIC BIC

ARMA(1,0)
ARMA(1,1)
ARMA(0,1)

Copyright © 1999-2001 IISEC Box-Jenkins Methodology – Test Data Set 1 Page 1

 For each model, use the Excel SOLVER function to find the coefficient values
which minimize the AIC (or BIC). The preferred model will have the overall
minimum AIC (or BIC).
4. Check the ACF and PACF of the residuals and perform the Durbin-Watson test
and the Box-Pierce and Ljung-Box portmanteau tests to test that the residuals are
white nose.
5. Check the forecasting ability of your chosen model by computing the coefficient
of determination R2 and Theil's U.

Copyright © 1999-2001 IISEC Box-Jenkins Methodology – Test Data Set 1 Page 2

 Box-Jenkins Methodology

Phase I
Identification Data Preparation
Ø Transform data to stabilize
variance
Ø Difference data to obtain
stationary series

Model Selection
Ø Use ACF and PACF to identify
appropriate models

Phase II
Estimation Estimation
and Testing Ø Derive MLE parameter
estimates for each model
Ø Use model selection criteria to
choose the best model

Diagnostics
Ø Chec k ACF/PACF of residuals
No
Ø Do portmanteau and other tests
of residuals
Ø Are residuals white noise?

Phase III Forecasting

Forecasting Ø Use model to forecast
Ø Test effectiveness of model
forecasting ability

Copyright © 1999-2001 IISEC Box-Jenkins Methodology – Test Data Set 1 Page 3

 Solution: `

Box-Jenkins Methodology -
Test Data Set 1
1. The ACF and the PACF of the time series are shown below. The positive,
geometrically decaying pattern of the ACF, coupled with the single significant
PACF coefficient φ 11 strongly suggest an AR(1) {=ARMA(1,0)} process.

ACF and PACF - Time Series

1.00

0.80 ACF

PACF

Upper 95%
0.60
Lower 95%

0.40

0.20

0.00
1

7
9

11

13
15

17

19

-0.20

-0.40

2. The class of models we are considering is of the form:

yt = ayt-1 + εt + βεt -1
Where, in the case of an ARMA(1,0) model β is zero, while in the case of an
ARMA(0,1) model a = 0.

Our forecast values are computed using the formula:

y't = a'yt-1 + β'et-1

Where a' and β are estimates of the model parameters a and β and et is the error
term (yt - y't).
Start by entering a dummy value for coefficient a in the cell C2 (named "aest").
Leave the β coefficient blank for now (so we are testing an AR(1) model).
Start by setting y' 1 = 0 (in cell D11). Compute e1 (1.034 - 0 = 1.034) in cell E11.

Copyright © 1999-2001 IISEC Box-Jenkins Methodology – Test Data Set 1 Page 4

 Then compute y'2 using the formula: y'2 = a'y'1 + b'e1. The Excel formulation is
=aest*C11+best*E11. This formula is placed in cell D12 and then copied down
into the remaining cells in the column.
Next, copy the formula for the error term in cell E11 down into the remaining
cells in that column.
To prepare the ANOVA, we need to compute the model sums of squares

SSM = ∑ ( yˆ t − y) 2

The excel formula is simply =(D13-AVERAGE($C$13:$C$110))^2, and this is

entered into cell F13 and copied down.
The error sums of squares SSE = Σ et2 can be computed directly using the Excel
formula: =SUMPRODUCT(E13:E110,E13:E110). This is entered into cell G4 in
the ANOVA table (the cell is named "SSE").
We are now ready to complete the ANOVA. Sum the model sums of squares by
entering the Excel formula =SUM(F13:F110) in cell G3 (named "SSM"). Add
SSM to SSE to compute the total sums of squares SST in cell G5. Next we
compute the model and error mean square terms by dividing SSM and SSE by
their respective degrees of freedom. Finally we can compute the F-statistic by
taking the ratio F = SSM/SSR. This has an F distribution with m and n-m-1
degrees of freedom. We use the Excel function FDIST to calculate the probability
of observing a value of F this large or larger (under the hypothesis that the model
parameters are zero). The p-value indicates that the model is statistically
significant at that probability level. If the p-value is small, the indication is that it
is likely that the model is useful in explaining some of the variation in the series.
A typical completed ANOVA table is shown below (for the AR(1) model):-

ANOVA DF SS MS F p
Model 1 127.35 127.3496 130.3163 1E-19
Error 96 93.81 0.977234
Total 97 221.16

3. :We can now compute the Akaike Information Criterion using the Excel formula
=n*LN(SSE)+2*m in cell M3. For comparison, we compute the Schwartz
Bayesian Information criterion (BIC) in cell M4 using the Excel Formula
=n*LN(SSE)+m*LN(n).

So far, we have been working with a dummy value of our model coefficients.
Now that we have computed the formula for the AIC (BIC) we can proceed to find
the maximum likelihood estimates of the coefficients. We do this by using Excel
SOLVER to find the coefficient values which minimize the AIC (or BIC).
To run SOLVER, go to the Forecasting commandbar and choose Solver. The
following dialog box appears:

Copyright © 1999-2001 IISECDF Box-Jenkins Methodology – pTest Data Set 1 Page 5

aest 0.766 ANOVA SS MS F Max Likelihood Portmanteau Tests
ββest Model 1 126.74 126.7426 129.6952 2E-19 AIC 447.05 Q(20) p
m 1 Error 96 93.81 0.977234 BIC 449.63 Box-Pierce 9.24 0.969
2
n 98 Total 97 220.56 R 57.5% Ljung-Box 10.60 0.956
Theil's U 1.003 Durbin-Watson 1.91
 Enter the cell reference of the AIC field (M3), which is the function to be
minimized. In the By Changing Cells field, enter the cell reference(s) of the
model parameters (C2 and C3). Click the Solve button and SOLVER will find the
minimum AIC using a gradient decent search method.

Using a similar technique to estimate the parameters for all three models, and the
corresponding AIC (and BIC), we arrive at the results shown in the table below.
These clearly indicate that, using either the AIC or BIC criteria, the preferred
model is the ARMA(1, 0) {= AR(1)} model

yt = 0.766yt-1 + εt

Model a-coefficent β -coefficient AIC BIC

ARMA(1,0) 0.766 - 447.1 449.6
ARMA(1,1) 0.732 0.083 448.8 453.8
ARMA(0,1) - 0.611 479.4 482

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4. The ACF and PACF of the residuals of the ARMA(1,0) model are shown in the
chart below. None of the coefficients appears to be statistically different from
zero.
ACF & PACF - Residuals

0.25
ACF
0.20 PACF

0.15 Upper 95%

Lower 95%
0.10
0.05
0.00
-0.05
1

9
11

13

15

17

19
-0.10
-0.15
-0.20
-0.25

We can use the portmanteau tests to verify that the 20 ACF coefficients are
collectively insignificant. The Excel formula for the Box-Pierce statistic Q(20) is
=n*SUMPRODUCT($I$11:$I$30,$I$11:$I$30), which returns a value of 9.24 in
cell P4. [Alternatively you can use the Box-Pierce function]. The Box-Pierce
statistic has a χ2 distribution with 20 - 1 = 19 degrees of freedom. Using the Excel
formula =CHIDIST(P4,B30-m) in cell Q4, we find that the probability of the
statistic taking this value or large is 96.9%. So we accept the hypothesis that the
residual ACF coefficients are insignificantly different from zero.
A similar test using the Ljung-Box statistic can be performed using the Excel
formula =n*(n+2)*SUMPRODUCT($I$11:$I$30,$I$11:$I$30,1/(n-
$B$11:$B$30)) in cell P5. Again the conclusion is that the residual ACF
coefficients are insignificant at the 95.6% level.
We can also check for serial correlation amongst the residuals using the Durbin-
Watson statistic:
n

∑ (e t − et −1 ) 2
DW = t=2
n

∑e
t =1
2
t

This can be computed using the DurbinWatson function or directly using the
following Excel formula:
=SUMPRODUCT($E$14:$E$110-$E$13:$E$109,$E$14:$E$110-$E$13:$E$109)
/ SUMPRODUCT($E$13:$E$110,$E$13:$E$110)

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 The result 1.89 indicates a lack or serial correlation and supports the hypothesis
that the residuals are white noise.
5. To test the forecasting performance of our model we compute the coefficient of
determination R2 using the Excel formula =SSM/SST in cell M5. The result
shows that our model can explain approximately 57% of the variation in the
series.

While this is encouraging, we can demonstrate that our model represents no

improvement over using the naï ve forecasting model yt = yt-1 + εt
We can compute Theil's U statistic (see below) using the Excel Theil function.
The Excel formula in cell M6 is =Theil(C13:C110,D13:D110), which returns a
result 1.003
This implies that our AR(1) model is slightly inferior to the naï ve forecasting
method in predicting one-period ahead percentage changes in the series.

2
n −1 n−1  ft +1 − yt +1 
∑ ( FPE t +1 − APEt +1 ) 2 ∑  
t =1  y 
U= t =1
n−1
= t
2
 yt +1 − yt 
∑ APE
n −1

∑
2
t +1  
t =1  
t =1 y t

Copyright © 1999-2001 IISEC Box-Jenkins Methodology – Test Data Set 1 Page 8