Multivariate Time Series Models

Abstract

The univariate time series methods and models described in Chapter 3 are based on one time series containing observations on the exchange rate to be forecast over a particular period of time. This chapter deals with multivariate time series models which, as the name implies, involve more than one time series. The time series may relate to various exchange rates to be forecast jointly or to an exchange rate and its determining variables. These models take the following forms. Single-equation economic models are also known as single-equation econometric models or reduced-form models. These models consist of a single equation that specifies the exchange rate (as the dependent variable) to be a function of some explanatory variables. They are ‘economic’ models because they are based on economic theory, unlike the models described in Chapter 3. They are ‘econometric’ models because they are estimated by using some econometric method such as OLS. They are ‘reduced-form’ models because the single equation explains the dependent (endogenous) variable in terms of other (exogenous) explanatory variables.A single equation structural time series model is similar to Harvey’s (1989) structural time series model, which was described in the previous chapter, except that it contains explanatory variables. In such a model, the exchange rate is determined by its time series components as well as some explanatory variables.