ALL THE INFORMATION IS CORRECT AND NOTHING IS MISSING

Question 5 Many time series used in finance are described as non-stationary series. a. What do we mean by non-stationary? Why is it important to test for non-stationarity and account for it in estimation? [4 marks] b. Three forms of standard Dickey-Fuller test are given below: A. Ayt = Pyt-1 + ut B. Ayt = atpyt-1+ ut C. Aye = a+ Bt + pyt-1+ ut Which of these forms would you use to test for non-stationarity in each of the following variables and why? 1. Stock prices ii. Stock returns iii. The residuals of an Engle-Granger test [2+2+2=6 marks] c. Consider the following data generating process for a series y: y, = #+1.5y, +u, What most accurately describes the process for Y:? How would you work with this model for yt? [4 marks] d. What difficulties can arise when applying and interpreting Dickey-Fuller tests? Describe in detail another test which could be applied to test for non-stationarity. [3+3 = 6 marks] [Total of Question 5 = 20 marks]