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A Vector Autoregression framework is used to examine the relationship between the real economy and the stock market. The quarterly variables in the VAR are: stock returns (SRE), Changes in real interest rate (IRE), growth in industrial production (IPG) and inflation (INF) and the VAR is assumed to be ordered as listed. a b c Write down the specification for a VAR(2) in these variables in structural form. [2 marks] Write down the specification of the VAR(2) in these variables in reduced form. [2 marks] The forecast error variance decomposition at 24 month horizon is given in Table 1.1. Comment on the following hypotheses using the data results: i Inflation has a substantial effect on stock market prices ii Variation in stock market prices explain variation in industrial production iii The model has good explanatory power iv Interest rates and stock returns are inversely related Table 1.1 Forecast error variance decomposition at 24 months Variables explained SRE IRE IPG INF d e SRE (%) 92.67 10.06 10.61 2.37 By innovation in IRE IPG (%) (%) 1.90 2.27 77.73 6.31 1.30 84.73 38.78 4.31 INF (%) 3.16 5.89 3.35 54.53 [8 marks] Based on the impulse responses provided in Figure 1.1, which variable is most affected by a stock market shock in the short-run? And in the long-run? [2 marks] Based on the impulse responses provided in Figure 1, what is the nature of the relationship between stock returns and interest rates. Explain. [2 marks] Figures 1a) to d) Impulse responses of Stock returns (SRE), Industrial production (IRE)