# VAR Model Estimation Overview

Decide on a set of VAR candidates to models, fit each model to the data, choose the model with the best fit, and then determine whether the AR polynomial of the estimated model is stable. Econometrics Toolbox™ has several functions that aid these tasks, including:

`estimate`

— Fit VAR model to data.`summarize`

— Display and returns parameter estimates and other summary statistics from an estimated model.`lratiotest`

or`aicbic`

— Determine the adequate number of lags by comparing the fit statistics of fitted models.`infer`

— Compute residuals of an estimated model for diagnostic checking.`forecast`

— Determine the predictive performance of a model by comparing forecasts to observed responses (see VAR Model Forecasting, Simulation, and Analysis)`LagOp`

and`isStable`

— Determine whether an AR polynomial is stable.

**Load Multivariate Economic Data**

Load the US macroeconomic data. Consider modeling the joint dynamics of the US gross domestic product (GDP), consumer price index (CPI), and unemployment rate series, and suppose government consumption expenditures is an exogenous variable. For more details on the data, see Format Multivariate Time Series Data.

load Data_USEconModel ynames = ["CPIAUCSL" "UNRATE" "GDP"]; xnames = "GCE"; DTT = DataTimeTable(:,[ynames xnames]);

### Prepare Data for Estimation

To fit a VAR model to your data, you must format, preprocess, and partition the multivariate data for estimation (see Format Multivariate Time Series Data).

**Format**:`varm`

object functions accept data in matrices, tables, or timetables. For timetables, row dates must be regular. Although the US macroeconomic data set contains the series in all those forms, the row dates of the timetable`DataTimeTable`

do not comprise a regular series. Because this example uses the timetable, the example addresses the irregular dates.**Preprocess**: When you plan to supply a timetable of data to`varm`

functions, you must ensure that the selected response variables are numeric, do not contain any missing values, and the timestamps in the`Time`

variable are regular and in ascending or descending order. Also, the series must be stationary.**Partition**: This example creates a set of candidate VAR($\mathit{p}$) models, where the order $\mathit{p}$ and lag terms present in the model vary. $\mathit{p}$ determines the required number of presample observations to initialize the model. This example uses a maximum of $\mathit{p}=8$; therefore the presample is the first 8 observations for all models. This example uses the AIC to determine the best fitting model. Therefore, this example fits the models to the remaining observations. However, you can partition the data further to use out-of-sample forecast measures to compare the models' predictive performance. How you partition the data depends on your analysis goals.

#### Remove Missing Values

Remove the observations from the head of the table that contain consecutive missing values.

DTT = rmmissing(DTT);

`rmmissing`

uses listwise deletion to remove all rows from the input timetable containing at least one missing observation.

#### Regularize Sample Dates

Determine whether the sampling timestamps have a regular frequency and are sorted.

`areTimestampsRegular = isregular(DTT,"quarters")`

`areTimestampsRegular = `*logical*
0

areTimestampsSorted = issorted(DTT.Time)

`areTimestampsSorted = `*logical*
1

`areTimestampsRegular = 0`

indicates that the timestamps of `DTT`

are irregular. `areTimestampsSorted = 1`

indicates that the timestamps are sorted. Macroeconomic series in this example are timestamped at the end of the month. This quality induces an irregularly measured series.

Remedy the time irregularity by shifting all dates to the first day of the quarter.

dt = DTT.Time; dt = dateshift(dt,"start","quarter"); DTT.Time = dt; areTimestampsRegular = isregular(DTT,"quarters")

`areTimestampsRegular = `*logical*
1

`DTT`

is regular.

#### Stabilize the Series

Econometrics Toolbox has a variety of functions that conduct statistical tests for stationary (see Unit Root Nonstationarity). This example inspects plots of the time series to determine whether the series must be stabilized.

Plot the response and predictor series in separate plots.

tiledlayout(2,2) for j = 1:width(DTT) nexttile plot(DTT.Time,DTT{:,j}) title(DTT.Properties.VariableNames(j)) end

By visual inspection:

The CPI, GDP, and GCE series exponentially increase. This example converts these series to rates (percents) by using

`price2ret`

.The unemployment rate series appears nonstationary. This example applies the first difference to the series.

Stabilize the series. Plot the stabilized series.

DTTt = price2ret(DTT,DataVariables=["CPIAUCSL" "GDP" "GCE"]); DTTt.Variables = DTTt.Variables*100; DTTt.UNRATE = diff(DTT.UNRATE); DTTt.Interval = []; tiledlayout(2,2) for j = 1:width(DTT) nexttile plot(DTTt.Time,DTTt{:,j}) title(DTTt.Properties.VariableNames(j)) end

Application of the first difference and conversion to rates reducing the effective sample size by 1.

#### Partition the Data

A VAR model with maximum order of 8 model requires 8 presample responses. Partition the data into presample and estimation samples.

maxp = 8; % Num. presample observations T = height(DTTt); % Total sample size eT = T - maxp; % Effective sample size idxpre = 1:maxp; idxest = (maxp + 1):T; DTT0 = DTTt(idxpre,:); % Presample DTTE = DTTt(idxest,:); % Estimation sample

### Specify Candidate VARX Models

Specify the candidate VARX models in the table, containing estimable parameters, by calling the `varm`

function (see Vector Autoregression (VAR) Model Creation). Each model contains an estimable constant and innovations covariance matrix.

$${\Phi}_{1}$$ | $${\Phi}_{4}$$ | $${\Phi}_{8}$$ | |
---|---|---|---|

$$\mathrm{VARX}\left(0\right)$$ | |||

$${\mathrm{VARX}\left(8\right)}_{1}$$ | x | ||

$${\mathrm{VARX}\left(4\right)}_{1}$$ | x | ||

$${\mathrm{VARX}\left(8\right)}_{2}$$ | x | x | |

$$\mathrm{VARX}\left(1\right)$$ | x | ||

$${\mathrm{VARX}\left(8\right)}_{3}$$ | x | x | |

$${\mathrm{VARX}\left(4\right)}_{2}$$ | x | x | |

$${\mathrm{VARX}\left(8\right)}_{4}$$ | x | x | x |

Create a design matrix that identifies which coefficients are present in the model.

numseries = numel(ynames); CoeffIdx = logical(ff2n(numseries))

`CoeffIdx = `*8x3 logical array*
0 0 0
0 0 1
0 1 0
0 1 1
1 0 0
1 0 1
1 1 0
1 1 1

nummdls = height(CoeffIdx);

Create the VARX models in a for loop. Store the models in a vector.

lags = [1 4 8]; Mdls(8) = varm(numseries,0); % Preallocate model vector for j = 1:nummdls coeffidx = lags(CoeffIdx(j,:)); Mdls(j) = varm(Constant=NaN(numseries,1),Lags=coeffidx, ... SeriesNames=ynames); end Mdls(4)

ans = varm with properties: Description: "3-Dimensional VAR(8) Model" SeriesNames: "CPIAUCSL" "UNRATE" "GDP" NumSeries: 3 P: 8 Constant: [3×1 vector of NaNs] AR: {3×3 matrices} at lags [4 8] Trend: [3×1 vector of zeros] Beta: [3×0 matrix] Covariance: [3×3 matrix of NaNs]

Mdls(4).AR'

`ans=`*8×1 cell array*
{3x3 double}
{3x3 double}
{3x3 double}
{3x3 double}
{3x3 double}
{3x3 double}
{3x3 double}
{3x3 double}

`Mdls`

is an 8-by-1 vector of `varm`

objects containing estimable parameters. `Mdls(4)`

matches the structure of the fourth model in the table. Lags 4 and 8 of the model contain coefficient matrices of `NaN`

values, which indicates that they are estimable. All other lags have coefficient matrices of zeros, which means that they are effectively absent from the model. The `Beta`

property is an empty matrix; MATLAB® populates `Beta`

during estimation when you specify predictor data.

### Fit Models to Data

The `estimate`

function fits an input `varm`

model containing estimable parameters to input data.

Estimate all VARX models in the vector. Store the results in a vector of estimated `varm`

objects. Obtain the AIC of each fit by extracting that statistic from the output of `summarize`

. Specify the entire presample for each estimation.

for j = nummdls:-1:1 EstMdls(j) = estimate(Mdls(j),DTTE,ResponseVariables=ynames, ... PredictorVariables=xnames,Presample=DTT0); StatsEstMdls(j) = summarize(EstMdls(j)); ic(j) = StatsEstMdls(j).AIC; end EstMdls(4)

ans = varm with properties: Description: "AR-Stationary 3-Dimensional VARX(8) Model with 1 Predictor" SeriesNames: "CPIAUCSL" "UNRATE" "GDP" NumSeries: 3 P: 8 Constant: [0.0016423 -0.0396456 0.010304]' AR: {3×3 matrices} at lags [4 8] Trend: [3×1 vector of zeros] Beta: [3×1 matrix] Covariance: [3×3 matrix]

`EstMdls`

is an 8-by-1 vector of `varm`

objects; `EstMdls(`

`j`

`)`

represents the estimated VAR model corresponding to the model structure `Mdls(`

`j`

`)`

. You can access parameter estimates by using dot notation. For example, display the exogenous regression coefficient matrix estimate and the lag 4 coefficient matrix.

EstMdls(4).SeriesNames

`ans = `*1x3 string*
"CPIAUCSL" "UNRATE" "GDP"

Beta = EstMdls(4).Beta

`Beta = `*3×1*
0.1184
-3.6739
0.2186

Phi4 = EstMdls(4).AR{4}

`Phi4 = `*3×3*
0.3060 -0.0012 0.0506
12.4739 -0.2332 1.5961
-0.0966 0.0058 0.0054

The rows and columns of the parameters correspond to the series in `EstMdls(4).SeriesNames`

.

#### How `estimate`

Works

Before fitting the model to data, `estimate`

requires at least $\mathit{p}$ presample observations to initialize the model. `varm`

stores the model degree $\mathit{p}$ in property `P`

of the `varm`

model object. This example specifies the presample so that the models can be fairly compared, but, by default, `estimate`

removes the first `P`

observations from the specified estimation sample. Therefore, if you let `estimate`

take requisite presample observations from the input estimation sample data, the effective sample size decreases.

`estimate`

computes maximum likelihood estimates of the parameters present in the model. Specifically, `estimate`

fits the estimable parameters corresponding to the `varm`

model properties `Constant`

, `AR`

, `Trend`

, `Beta`

, and `Covariance`

. For VAR models, `estimate`

uses a direct solution algorithm that requires no iterations. For VARX models, `estimate`

optimizes the likelihood using the expectation-conditional-maximization (ECM) algorithm. The iterations usually converge quickly, unless two or more exogenous data streams are proportional to each other. In that case, no unique maximum likelihood estimator exists, and, consequently, the algorithm might not converge on a solution. You can set the maximum number of iterations with the `MaxIterations`

name-value argument, which has a default value of `1000`

.

Unlike univariate conditional mean and variance model estimation (for example, `arima`

and `garch`

model estimation), `estimate`

performs unrestricted maximum likelihood. Therefore, `estimate`

can return an unstable VAR model.

For numeric array data inputs, `estimate`

removes entire observations from the data containing at least one missing value (`NaN`

). For table or timetable data inputs, `estimate`

issues an error when any observation is missing. For more details, see `estimate`

.

`estimate`

calculates the loglikelihood of the data, and then returns it as an output of the fitted model. You can use this output in testing the quality of the model. For example, see Select Appropriate Lag Order.

### Choose Best Fitting Model

Choose the model with the best fit by finding the estimated model that minimizes the AIC.

[~,bestIdx] = min(ic)

bestIdx = 8

The best fitting model is the VARX(8) model that includes lags ${\Phi}_{1}$, ${\Phi}_{4}$, and ${\Phi}_{8}$.

Summarize the best fitting model.

BestFitEstMdl = EstMdls(bestIdx); summarize(BestFitEstMdl)

AR-Stationary 3-Dimensional VARX(8) Model with 1 Predictor Effective Sample Size: 236 Number of Estimated Parameters: 33 LogLikelihood: 1580.02 AIC: -3094.04 BIC: -2979.73 Value StandardError TStatistic PValue ___________ _____________ __________ __________ Constant(1) 0.00042224 0.0014111 0.29923 0.76477 Constant(2) 0.083343 0.066472 1.2538 0.20991 Constant(3) 0.0080822 0.0018504 4.3678 1.255e-05 AR{1}(1,1) 0.38803 0.070814 5.4796 4.2641e-08 AR{1}(2,1) 5.6013 3.3358 1.6791 0.093124 AR{1}(3,1) 0.19235 0.09286 2.0714 0.038323 AR{1}(1,2) -0.00011792 0.0015733 -0.074949 0.94026 AR{1}(2,2) 0.28432 0.074114 3.8362 0.00012494 AR{1}(3,2) -0.0070376 0.0020631 -3.4111 0.00064697 AR{1}(1,3) 0.10432 0.059929 1.7407 0.081729 AR{1}(2,3) -8.662 2.8231 -3.0683 0.0021531 AR{1}(3,3) 0.15497 0.078588 1.9719 0.048618 AR{4}(1,1) 0.11635 0.075627 1.5384 0.12395 AR{4}(2,1) 7.344 3.5626 2.0614 0.039261 AR{4}(3,1) -0.12058 0.099172 -1.2158 0.22405 AR{4}(1,2) -0.0012109 0.0015642 -0.77417 0.43883 AR{4}(2,2) -0.20262 0.073684 -2.7499 0.0059612 AR{4}(3,2) 0.0052556 0.0020512 2.5623 0.010399 AR{4}(1,3) 0.02242 0.059003 0.37998 0.70396 AR{4}(2,3) 0.70129 2.7795 0.25231 0.8008 AR{4}(3,3) -0.0090903 0.077373 -0.11749 0.90647 AR{8}(1,1) 0.071877 0.067845 1.0594 0.2894 AR{8}(2,1) 0.37516 3.196 0.11738 0.90656 AR{8}(3,1) 0.13963 0.088968 1.5695 0.11654 AR{8}(1,2) 0.00015779 0.0015394 0.1025 0.91836 AR{8}(2,2) -0.19092 0.072518 -2.6326 0.0084722 AR{8}(3,2) 0.00618 0.0020187 3.0614 0.0022032 AR{8}(1,3) 0.02496 0.055678 0.4483 0.65394 AR{8}(2,3) -1.8024 2.6229 -0.68718 0.49197 AR{8}(3,3) 0.13983 0.073013 1.9151 0.055475 Beta(1,1) 0.058412 0.026055 2.2419 0.024966 Beta(2,1) -1.5393 1.2274 -1.2542 0.20978 Beta(3,1) 0.14514 0.034166 4.248 2.1573e-05 Innovations Covariance Matrix: 0.0000 -0.0000 0.0000 -0.0000 0.1107 -0.0017 0.0000 -0.0017 0.0001 Innovations Correlation Matrix: 1.0000 -0.0123 0.2560 -0.0123 1.0000 -0.5376 0.2560 -0.5376 1.0000

**Examine Stability of AR Polynomial**

When you enter the name of a fitted model at the command line, you obtain a object summary. In the `Description`

row of the summary (which shows the value of the `Description`

property), `varm`

indicates whether the VAR model (or, the AR polynomial of the model) is stable.

Another way to determine whether a VAR model is stationary of the VAR model is to create a lag operator polynomial object using the estimated autoregression coefficients (see `LagOp`

), and then passing the lag operator to the `isStable`

function.

Determine whether the best fitting model `BestFitEstMdl`

is stable using lag operator polynomial objects. Observe that `LagOp`

requires the coefficient of lag `0`

.

AR = [{eye(numseries)} BestFitEstMdl.AR]; % Include the lag 0 coefficient. Mdl = LagOp(AR); Mdl = reflect(Mdl); % Negate all lags > 0 isStable(Mdl)

`ans = `*logical*
1

`isStable`

returns the logical value `1`

, indicating that the best fitting model is stable. Regression components can destabilize an otherwise stable VAR model. This process determines the stability of the VAR polynomial in the model.

Stable models yield reliable results, while unstable ones might not.

Model stability is equivalent to all eigenvalues of the associated lag operators having modulus less than 1; `isStable`

evaluates model stability by calculating eigenvalues. For more information, see `isStable`

and Hamilton [1].

## References

[1] Hamilton, James D. *Time Series Analysis*. Princeton, NJ: Princeton University Press, 1994.