Code should execute sequentially if run in a Jupyter notebook

Co-authors: Chase Coleman and Balint Szoke

## Overview¶

Some time series are nonstationary

For example, output, prices, and dividends are typically nonstationary, due to irregular but persistent growth

Which kinds of models are useful for studying such time series?

Hansen and Scheinkman [HS09] analyze two classes of time series models that accommodate growth

They are:

1. additive functionals that display random “arithmetic growth”
2. multiplicative functionals that display random “geometric growth”

These two classes of processes are closely connected

For example, if a process $$\{y_t\}$$ is an additive functional and $$\phi_t = \exp(y_t)$$, then $$\{\phi_t\}$$ is a multiplicative functional

Hansen and Sargent [HS17] (chs. 5 and 6) describe discrete time versions of additive and multiplicative functionals

In this lecture we discuss the former (i.e., additive functionals)

In the next lecture we discuss multiplicative functionals

We also consider fruitful decompositions of additive and multiplicative processes, a more in depth discussion of which can be found in Hansen and Sargent [HS17]

This lecture focuses on a particular type of additive functional: a scalar process $$\{y_t\}_{t=0}^\infty$$ whose increments are driven by a Gaussian vector autoregression

It is simple to construct, simulate, and analyze

This additive functional consists of two components, the first of which is a first-order vector autoregression (VAR)

(1)$x_{t+1} = A x_t + B z_{t+1}$

Here

• $$x_t$$ is an $$n \times 1$$ vector,
• $$A$$ is an $$n \times n$$ stable matrix (all eigenvalues lie within the open unit circle),
• $$z_{t+1} \sim {\cal N}(0,I)$$ is an $$m \times 1$$ i.i.d. shock,
• $$B$$ is an $$n \times m$$ matrix, and
• $$x_0 \sim {\cal N}(\mu_0, \Sigma_0)$$ is a random initial condition for $$x$$

The second component is an equation that expresses increments of $$\{y_t\}_{t=0}^\infty$$ as linear functions of

• a scalar constant $$\nu$$,
• the vector $$x_t$$, and
• the same Gaussian vector $$z_{t+1}$$ that appears in the VAR (1)

In particular,

(2)$y_{t+1} - y_{t} = \nu + D x_{t} + F z_{t+1}$

Here $$y_0 \sim {\cal N}(\mu_{y0}, \Sigma_{y0})$$ is a random initial condition

The nonstationary random process $$\{y_t\}_{t=0}^\infty$$ displays systematic but random arithmetic growth

### A linear state space representation¶

One way to represent the overall dynamics is to use a linear state space system

To do this, we set up state and observation vectors

$\begin{split}\hat{x}_t = \begin{bmatrix} 1 \\ x_t \\ y_t \end{bmatrix} \quad \text{and} \quad \hat{y}_t = \begin{bmatrix} x_t \\ y_t \end{bmatrix}\end{split}$

Now we construct the state space system

$\begin{split} \begin{bmatrix} 1 \\ x_{t+1} \\ y_{t+1} \end{bmatrix} = \begin{bmatrix} 1 & 0 & 0 \\ 0 & A & 0 \\ \nu & D' & 1 \\ \end{bmatrix} \begin{bmatrix} 1 \\ x_t \\ y_t \end{bmatrix} + \begin{bmatrix} 0 \\ B \\ F' \end{bmatrix} z_{t+1}\end{split}$
$\begin{split}\begin{bmatrix} x_t \\ y_t \end{bmatrix} = \begin{bmatrix} 0 & I & 0 \\ 0 & 0 & 1 \end{bmatrix} \begin{bmatrix} 1 \\ x_t \\ y_t \end{bmatrix}\end{split}$

This can be written as

\begin{split}\begin{aligned} \hat{x}_{t+1} &= \hat{A} \hat{x}_t + \hat{B} z_{t+1} \\ \hat{y}_{t} &= \hat{D} \hat{x}_t \end{aligned}\end{split}

which is a standard linear state space system

To study it, we could map it into an instance of LSS from QuantEcon.jl

We will in fact use a different set of code for simulation, for reasons described below

## Dynamics¶

Let’s run some simulations to build intuition

In doing so we’ll assume that $$z_{t+1}$$ is scalar and that $$\tilde x_t$$ follows a 4th-order scalar autoregession

(3)$\tilde x_{t+1} = \phi_1 \tilde x_{t} + \phi_2 \tilde x_{t-1} + \phi_3 \tilde x_{t-2} + \phi_4 \tilde x_{t-3} + \sigma z_{t+1}$

Let the increment in $$\{y_t\}$$ obey

$y_{t+1} - y_t = \nu + \tilde x_t + \sigma z_{t+1}$

with an initial condition for $$y_0$$

While (3) is not a first order system like (1), we know that it can be mapped into a first order system

In fact this whole model can be mapped into the additive functional system definition in (1)(2) by appropriate selection of the matrices $$A, B, D, F$$

You can try writing these matrices down now as an exercise — the correct expressions will appear in the code below

### Simulation¶

When simulating we embed our variables into a bigger system

This system also constructs the components of the decompositions of $$y_t$$ and of $$\exp(y_t)$$ proposed by Hansen and Scheinkman [HS09]

All of these objects are computed using the code below

#=

Author: Shunsuke Hori

=#
using QuantEcon
using PyPlot
using Distributions

"""
This type transforms an additive (multipilcative)
functional into a QuantEcon linear state space system.
"""
struct AMF_LSS_VAR{TF<:AbstractFloat, TI<:Integer}
A::Array{TF, 2}
B::Array{TF, 2}
D::Array{TF, 2}
F::Array{TF, 2}
ν::Array{TF, 2}
nx::TI
nk::TI
nm::TI
lss::LSS
end

function AMF_LSS_VAR(A::Array, B::Array,
D::Union{RowVector, Array},
F::Union{Void, Array}=nothing;
ν::Union{Void, Array}=nothing)

if typeof(B) <: Vector
B = reshape(B, length(B), 1)
end
# Unpack required elements
nx, nk = size(B)

# checking the dimension of D (extended from the scalar case)
if ndims(D) > 1
nm = size(D, 1)
if typeof(D) <: RowVector
D = convert(Matrix, D)
end
else
nm = 1
D = reshape(D, 1, length(D))
end

# Set F
if F==nothing
F = zeros(nk, 1)
elseif ndims(F) == 1
F = reshape(F, length(F), 1)
end

# Set ν
if ν==nothing
ν = zeros(nm, 1)
elseif ndims(ν) == 1
ν = reshape(ν, length(ν), 1)
else
throw(ArgumentError("ν must be column vector!"))
end

if size(ν, 1) != size(D, 1)
error("The size of ν is inconsistent with D!")
end

# Construct BIG state space representation
lss = construct_ss(A, B, D, F, ν, nx, nk, nm)

return AMF_LSS_VAR(A, B, D, F, ν, nx, nk, nm, lss)
end

AMF_LSS_VAR(A::Array, B::Array, D::Union{RowVector, Array}) =
AMF_LSS_VAR(A, B, D, nothing, ν=nothing)
AMF_LSS_VAR(A::Array, B::Array, D::Union{RowVector, Array}, F::Real, ν::Real) =
AMF_LSS_VAR(A, B, D, [F], ν=[ν])

"""
This creates the state space representation that can be passed
into the quantecon LSS {{ class_word }}.
"""
function construct_ss(A::Array, B::Array, D::Union{RowVector, Array}, F::Array,
ν, nx::TI, nk::TI, nm::TI) where TI <: Integer

H, g = additive_decomp(A, B, D, F, nx)

# Auxiliary blocks with 0's and 1's to fill out the lss matrices
nx0c = zeros(nx, 1)
nx0r = zeros(1, nx)
nx1 = ones(1, nx)
nk0 = zeros(1, nk)
ny0c = zeros(nm, 1)
ny0r = zeros(1, nm)
ny1m = eye(nm)
ny0m = zeros(nm, nm)
nyx0m = zeros(D)

# Build A matrix for LSS
# Order of states is: [1, t, xt, yt, mt]
A1 = hcat(1, 0, nx0r, ny0r, ny0r)          # Transition for 1
A2 = hcat(1, 1, nx0r, ny0r, ny0r)          # Transition for t
A3 = hcat(nx0c, nx0c, A, nyx0m', nyx0m')   # Transition for x_{t+1}
A4 = hcat(ν, ny0c, D, ny1m, ny0m)          # Transition for y_{t+1}
A5 = hcat(ny0c, ny0c, nyx0m, ny0m, ny1m)   # Transition for m_{t+1}
Abar = vcat(A1, A2, A3, A4, A5)

# Build B matrix for LSS
Bbar = vcat(nk0, nk0, B, F, H)

# Build G matrix for LSS
# Order of observation is: [xt, yt, mt, st, tt]
G1 = hcat(nx0c, nx0c, eye(nx), nyx0m', nyx0m')    # Selector for x_{t}
G2 = hcat(ny0c, ny0c, nyx0m, ny1m, ny0m)          # Selector for y_{t}
G3 = hcat(ny0c, ny0c, nyx0m, ny0m, ny1m)          # Selector for martingale
G4 = hcat(ny0c, ny0c, -g, ny0m, ny0m)             # Selector for stationary
G5 = hcat(ny0c, ν, nyx0m, ny0m, ny0m)             # Selector for trend
Gbar = vcat(G1, G2, G3, G4, G5)

# Build LSS type
x0 = hcat(1, 0, nx0r, ny0r, ny0r)
S0 = zeros(length(x0), length(x0))
lss = LSS(Abar, Bbar, Gbar, zeros(nx+4nm, 1), x0, S0)

return lss
end

"""
Return values for the martingale decomposition
- ν         : unconditional mean difference in Y
- H         : coefficient for the (linear) martingale component (kappa_a)
- g         : coefficient for the stationary component g(x)
- Y_0       : it should be the function of X_0 (for now set it to 0.0)
"""
function additive_decomp(A::Array, B::Array, D::Array, F::Union{Array, Real},
nx::Integer)
I = eye(nx)
A_res = $$I-A, I) g = D * A_res H = F + D * A_res * B return H, g end """ Return values for the multiplicative decomposition (Example 5.4.4.) - ν_tilde : eigenvalue - H : vector for the Jensen term """ function multiplicative_decomp(A::Array, B::Array, D::Array, F::Union{Array, Real}, ν::Union{Array, Real}, nx::Integer) H, g = additive_decomp(A, B, D, F, nx) ν_tilde = ν + 0.5*diag(H*H') return H, g, ν_tilde end function loglikelihood_path(amf::AMF_LSS_VAR, x::Array, y::Array) A, B, D, F = amf.A, amf.B, amf.D, amf.F k, T = size(y) FF = F*F' FFinv = inv(FF) temp = y[:, 2:end]-y[:, 1:end-1] - D*x[:, 1:end-1] obs = temp .* FFinv .* temp obssum = cumsum(obs) scalar = (log(det(FF)) + k*log(2*pi))*collect(1:T) return -0.5*(obssum + scalar) end function loglikelihood(amf::AMF_LSS_VAR, x::Array, y::Array) llh = loglikelihood_path(amf, x, y) return llh[end] end """ Plots for the additive decomposition """ function plot_additive(amf::AMF_LSS_VAR, T::Integer; npaths::Integer=25, show_trend::Bool=true) # Pull out right sizes so we know how to increment nx, nk, nm = amf.nx, amf.nk, amf.nm # Allocate space (nm is the number of additive functionals - we want npaths for each) mpath = Array{Real}(nm*npaths, T) mbounds = Array{Real}(nm*2, T) spath = Array{Real}(nm*npaths, T) sbounds = Array{Real}(nm*2, T) tpath = Array{Real}(nm*npaths, T) ypath = Array{Real}(nm*npaths, T) # Simulate for as long as we wanted moment_generator = moment_sequence(amf.lss) state = start(moment_generator) # Pull out population moments for t in 1:T tmoms, state = next(moment_generator, state) ymeans = tmoms[2] yvar = tmoms[4] # Lower and upper bounds - for each additive functional for ii in 1:nm li, ui = (ii-1)*2+1, ii*2 if sqrt(yvar[nx+nm+ii, nx+nm+ii]) != 0.0 madd_dist = Normal(ymeans[nx+nm+ii], sqrt(yvar[nx+nm+ii, nx+nm+ii])) mbounds[li, t] = quantile(madd_dist, 0.01) mbounds[ui, t] = quantile(madd_dist, 0.99) elseif sqrt(yvar[nx+nm+ii, nx+nm+ii]) == 0.0 mbounds[li, t] = ymeans[nx+nm+ii] mbounds[ui, t] = ymeans[nx+nm+ii] else error("standard error is negative") end if sqrt(yvar[nx+2*nm+ii, nx+2*nm+ii]) != 0.0 sadd_dist = Normal(ymeans[nx+2*nm+ii], sqrt(yvar[nx+2*nm+ii, nx+2*nm+ii])) sbounds[li, t] = quantile(sadd_dist, 0.01) sbounds[ui, t] = quantile(sadd_dist, 0.99) elseif sqrt(yvar[nx+2*nm+ii, nx+2*nm+ii]) == 0.0 sbounds[li, t] = ymeans[nx+2*nm+ii] sbounds[ui, t] = ymeans[nx+2*nm+ii] else error("standard error is negative") end end end # Pull out paths for n in 1:npaths x, y = simulate(amf.lss,T) for ii in 0:nm-1 ypath[npaths*ii+n, :] = y[nx+ii+1, :] mpath[npaths*ii+n, :] = y[nx+nm + ii+1, :] spath[npaths*ii+n, :] = y[nx+2*nm + ii+1, :] tpath[npaths*ii+n, :] = y[nx+3*nm + ii+1, :] end end add_figs = Array{Any}(nm) for ii in 0:nm-1 li, ui = npaths*(ii), npaths*(ii+1) LI, UI = 2*(ii), 2*(ii+1) add_figs[ii+1] = plot_given_paths(T, ypath[li+1:ui, :], mpath[li+1:ui, :], spath[li+1:ui, :], tpath[li+1:ui, :], mbounds[LI+1:UI, :], sbounds[LI+1:UI, :], show_trend=show_trend) add_figs[ii+1][:suptitle]( L"Additive decomposition of y_{(ii+1)}", fontsize=14 ) end return add_figs end """ Plots for the multiplicative decomposition """ function plot_multiplicative(amf::AMF_LSS_VAR, T::Integer, npaths::Integer=25, show_trend::Bool=true) # Pull out right sizes so we know how to increment nx, nk, nm = amf.nx, amf.nk, amf.nm # Matrices for the multiplicative decomposition H, g, ν_tilde = multiplicative_decomp(A, B, D, F, ν, nx) # Allocate space (nm is the number of functionals - we want npaths for each) mpath_mult = Array{Real}(nm*npaths, T) mbounds_mult = Array{Real}(nm*2, T) spath_mult = Array{Real}(nm*npaths, T) sbounds_mult = Array{Real}(nm*2, T) tpath_mult = Array{Real}(nm*npaths, T) ypath_mult = Array{Real}(nm*npaths, T) # Simulate for as long as we wanted moment_generator = moment_sequence(amf.lss) state = start(moment_generator) # Pull out population moments for t in 1:T tmoms, state = next(moment_generator, state) ymeans = tmoms[2] yvar = tmoms[4] # Lower and upper bounds - for each multiplicative functional for ii in 1:nm li, ui = (ii-1)*2+1, ii*2 if yvar[nx+nm+ii, nx+nm+ii] != 0.0 Mdist = LogNormal(ymeans[nx+nm+ii]- t*0.5*diag(H * H')[ii], sqrt(yvar[nx+nm+ii, nx+nm+ii])) mbounds_mult[li, t] = quantile(Mdist, 0.01) mbounds_mult[ui, t] = quantile(Mdist, 0.99) elseif yvar[nx+nm+ii, nx+nm+ii] == 0.0 mbounds_mult[li, t] = exp.(ymeans[nx+nm+ii]- t*0.5*diag(H * H')[ii]) mbounds_mult[ui, t] = exp.(ymeans[nx+nm+ii]- t*0.5*diag(H * H')[ii]) else error("standard error is negative") end if yvar[nx+2*nm+ii, nx+2*nm+ii] != 0.0 Sdist = LogNormal(-ymeans[nx+2*nm+ii], sqrt(yvar[nx+2*nm+ii, nx+2*nm+ii])) sbounds_mult[li, t] = quantile(Sdist, 0.01) sbounds_mult[ui, t] = quantile(Sdist, 0.99) elseif yvar[nx+2*nm+ii, nx+2*nm+ii] == 0.0 sbounds_mult[li, t] = exp.(-ymeans[nx+2*nm+ii]) sbounds_mult[ui, t] = exp.(-ymeans[nx+2*nm+ii]) else error("standard error is negative") end end end # Pull out paths for n in 1:npaths x, y = simulate(amf.lss,T) for ii in 0:nm-1 ypath_mult[npaths*ii+n, :] = exp.(y[nx+ii+1, :]) mpath_mult[npaths*ii+n, :] = exp.(y[nx+nm + ii+1, :] - collect(1:T)*0.5*diag(H * H')[ii+1]) spath_mult[npaths*ii+n, :] = 1./exp.(-y[nx+2*nm + ii+1, :]) tpath_mult[npaths*ii+n, :] = exp.(y[nx+3*nm + ii+1, :] + collect(1:T)*0.5*diag(H * H')[ii+1]) end end mult_figs = Array{Any}(nm) for ii in 0:nm-1 li, ui = npaths*(ii), npaths*(ii+1) LI, UI = 2*(ii), 2*(ii+1) mult_figs[ii+1] = plot_given_paths(T, ypath_mult[li+1:ui, :], mpath_mult[li+1:ui, :], spath_mult[li+1:ui, :], tpath_mult[li+1:ui, :], mbounds_mult[LI+1:UI, :], sbounds_mult[LI+1:UI, :], horline = 1.0, show_trend=show_trend) mult_figs[ii+1][:suptitle]( L"Multiplicative decomposition of y_{(ii+1)}", fontsize=14) end return mult_figs end function plot_martingales(amf::AMF_LSS_VAR, T::Integer, npaths::Integer=25) # Pull out right sizes so we know how to increment nx, nk, nm = amf.nx, amf.nk, amf.nm # Matrices for the multiplicative decomposition H, g, ν_tilde = multiplicative_decomp(amf.A, amf.B, amf.D, amf.F, amf.ν, amf.nx) # Allocate space (nm is the number of functionals - we want npaths for each) mpath_mult = Array{Real}(nm*npaths, T) mbounds_mult = Array{Real}(nm*2, T) # Simulate for as long as we wanted moment_generator = moment_sequence(amf.lss) state = start(moment_generator) # Pull out population moments for t in 1:T tmoms, state = next(moment_generator, state) ymeans = tmoms[2] yvar = tmoms[4] # Lower and upper bounds - for each functional for ii in 1:nm li, ui = (ii-1)*2+1, ii*2 if yvar[nx+nm+ii, nx+nm+ii] != 0.0 Mdist = LogNormal(ymeans[nx+nm+ii]-t*(.5)*diag(H*H')[ii], sqrt(yvar[nx+nm+ii, nx+nm+ii])) mbounds_mult[li, t] = quantile(Mdist, 0.01) mbounds_mult[ui, t] = quantile(Mdist, 0.99) elseif yvar[nx+nm+ii, nx+nm+ii] == 0.0 mbounds_mult[li, t] = ymeans[nx+nm+ii]-t*(.5)*diag(H*H')[ii] mbounds_mult[ui, t] = ymeans[nx+nm+ii]-t*(.5)*diag(H*H')[ii] else error("standard error is negative") end end end # Pull out paths for n in 1:npaths x, y = simulate(amf.lss, T) for ii in 0:nm-1 mpath_mult[npaths*ii+n, :] = exp.(y[nx+nm + ii+1, :] - (1:T)*0.5*diag(H*H')[ii+1]) end end mart_figs = Array{Any}(nm) for ii in 0:nm-1 li, ui = npaths*(ii), npaths*(ii+1) LI, UI = 2*(ii), 2*(ii+1) mart_figs[ii+1] = plot_martingale_paths(T, mpath_mult[li+1:ui, :], mbounds_mult[LI+1:UI, :], horline=1) mart_figs[ii+1][:suptitle](L"Martingale components for many paths of y_{ii+1}", fontsize=14) end return mart_figs end function plot_given_paths(T::Integer, ypath::Array, mpath::Array, spath::Array, tpath::Array, mbounds::Array, sbounds::Array; horline::Real=0.0, show_trend::Bool = true) # Allocate space trange = 1:T # Create figure fig, ax = subplots(2, 2, sharey=true, figsize=(15, 8)) # Plot all paths together ax[1, 1][:plot](trange, ypath[1, :], label=L"y_t", color="k") ax[1, 1][:plot](trange, mpath[1, :], label=L"m_t", color="m") ax[1, 1][:plot](trange, spath[1, :], label=L"s_t", color="g") if show_trend == true ax[1, 1][:plot](trange, tpath[1, :], label=L"t_t", color="r") end ax[1, 1][:axhline](horline, color="k", linestyle = "-.") ax[1, 1][:set_title]("One Path of All Variables") ax[1, 1][:legend](loc="top left") # Plot Martingale Component ax[1, 2][:plot](trange, mpath[1, :], "m") ax[1, 2][:plot](trange, mpath', alpha=0.45, color="m") ub = mbounds[2, :] lb = mbounds[1, :] ax[1, 2][:fill_between](trange, lb, ub, alpha=0.25, color="m") ax[1, 2][:set_title]("Martingale Components for Many Paths") ax[1, 2][:axhline](horline, color="k", linestyle = "-.") # Plot Stationary Component ax[2, 1][:plot](spath[1, :], color="g") ax[2, 1][:plot](spath', alpha=0.25, color="g") ub = sbounds[2, :] lb = sbounds[1, :] ax[2, 1][:fill_between](trange, lb, ub, alpha=0.25, color="g") ax[2, 1][:axhline](horline, color="k", linestyle = "-.") ax[2, 1][:set_title]("Stationary Components for Many Paths") # Plot Trend Component if show_trend == true ax[2, 2][:plot](tpath', color="r") end ax[2, 2][:set_title]("Trend Components for Many Paths") ax[2, 2][:axhline](horline, color="k", linestyle = "-.") return fig end function plot_martingale_paths(T::Integer, mpath::Array, mbounds::Array; horline::Real=1, show_trend::Bool = false) # Allocate space trange = 1:T # Create figure fig, ax = subplots(1, 1, figsize=(10, 6)) # Plot Martingale Component ub = mbounds[2, :] lb = mbounds[1, :] ax[:fill_between](trange, lb, ub, color="#ffccff") ax[:axhline](horline, color="k", linestyle = "-.") ax[:plot](trange, mpath', linewidth=0.25, color="#4c4c4c") return fig end  For now, we just plot \(y_t$$ and $$x_t$$, postponing until later a description of exactly how we compute them

ϕ_1, ϕ_2, ϕ_3, ϕ_4 = 0.5, -0.2, 0, 0.5
σ = 0.01
ν = 0.01 # Growth rate

# A matrix should be n x n
A = [ϕ_1 ϕ_2 ϕ_3 ϕ_4;
1   0   0   0;
0   1   0   0;
0   0   1   0]

# B matrix should be n x k
B = [σ, 0, 0, 0]

D = [1 0 0 0] * A
F = dot([1, 0, 0, 0], vec(B))

amf = AMF_LSS_VAR(A, B, D, F, ν)

T = 150
x, y = simulate(amf.lss, T)

fig, ax = subplots(2, 1, figsize = (10, 9))

ax[1][:plot](1:T, y[amf.nx+1, :], color="k")
ax[1][:set_title]("A particular path of "*L"$y_t$")
ax[2][:plot](1:T, y[1, :], color="g")
ax[2][:axhline](0, color="k", linestyle="-.")
ax[2][:set_title]("Associated path of "*L"x_t")


Notice the irregular but persistent growth in $$y_t$$

### Decomposition¶

Hansen and Sargent [HS17] describe how to construct a decomposition of an additive functional into four parts:

• a constant inherited from initial values $$x_0$$ and $$y_0$$
• a linear trend
• a martingale
• an (asymptotically) stationary component

To attain this decomposition for the particular class of additive functionals defined by (1) and (2), we first construct the matrices

\begin{split}\begin{aligned} H & := F + B'(I - A')^{-1} D \\ g & := D' (I - A)^{-1} \end{aligned}\end{split}

Then the Hansen-Scheinkman [HS09] decomposition is

\begin{aligned} y_t &= \underbrace{t \nu}_{\text{trend component}} + \overbrace{\sum_{j=1}^t H z_j}^{\text{Martingale component}} - \underbrace{g x_t}_{\text{stationary component}} + \overbrace{g x_0 + y_0}^{\text{initial conditions}} \end{aligned}

At this stage you should pause and verify that $$y_{t+1} - y_t$$ satisfies (2)

It is convenient for us to introduce the following notation:

• $$\tau_t = \nu t$$ , a linear, deterministic trend
• $$m_t = \sum_{j=1}^t H z_j$$, a martingale with time $$t+1$$ increment $$H z_{t+1}$$
• $$s_t = g x_t$$, an (asymptotically) stationary component

We want to characterize and simulate components $$\tau_t, m_t, s_t$$ of the decomposition.

A convenient way to do this is to construct an appropriate instance of a linear state space system by using LSS from QuantEcon.jl

This will allow us to use the routines in LSS to study dynamics

To start, observe that, under the dynamics in (1) and (2) and with the definitions just given,

$\begin{split}\begin{bmatrix} 1 \\ t+1 \\ x_{t+1} \\ y_{t+1} \\ m_{t+1} \end{bmatrix} = \begin{bmatrix} 1 & 0 & 0 & 0 & 0 \\ 1 & 1 & 0 & 0 & 0 \\ 0 & 0 & A & 0 & 0 \\ \nu & 0 & D' & 1 & 0 \\ 0 & 0 & 0 & 0 & 1 \end{bmatrix} \begin{bmatrix} 1 \\ t \\ x_t \\ y_t \\ m_t \end{bmatrix} + \begin{bmatrix} 0 \\ 0 \\ B \\ F' \\ H' \end{bmatrix} z_{t+1}\end{split}$

and

$\begin{split}\begin{bmatrix} x_t \\ y_t \\ \tau_t \\ m_t \\ s_t \end{bmatrix} = \begin{bmatrix} 0 & 0 & I & 0 & 0 \\ 0 & 0 & 0 & 1 & 0 \\ 0 & \nu & 0 & 0 & 0 \\ 0 & 0 & 0 & 0 & 1 \\ 0 & 0 & -g & 0 & 0 \end{bmatrix} \begin{bmatrix} 1 \\ t \\ x_t \\ y_t \\ m_t \end{bmatrix}\end{split}$

With

$\begin{split}\tilde{x} := \begin{bmatrix} 1 \\ t \\ x_t \\ y_t \\ m_t \end{bmatrix} \quad \text{and} \quad \tilde{y} := \begin{bmatrix} x_t \\ y_t \\ \tau_t \\ m_t \\ s_t \end{bmatrix}\end{split}$

we can write this as the linear state space system

\begin{split}\begin{aligned} \tilde{x}_{t+1} &= \tilde{A} \tilde{x}_t + \tilde{B} z_{t+1} \\ \tilde{y}_{t} &= \tilde{D} \tilde{x}_t \end{aligned}\end{split}

By picking out components of $$\tilde y_t$$, we can track all variables of interest

## Code¶

The type AMF_LSS_VAR mentioned above does all that we want to study our additive functional

In fact AMF_LSS_VAR does more, as we shall explain below

(A hint that it does more is the name of the type – here AMF stands for “additive and multiplicative functional” – the code will do things for multiplicative functionals too)

Let’s use this code (embedded above) to explore the example process described above

If you run the code that first simulated that example again and then the method call

plot_additive(amf, T)


you will generate (modulo randomness) the plot

When we plot multiple realizations of a component in the 2nd, 3rd, and 4th panels, we also plot population 95% probability coverage sets computed using the LSS type

We have chosen to simulate many paths, all starting from the same nonrandom initial conditions $$x_0, y_0$$ (you can tell this from the shape of the 95% probability coverage shaded areas)

Notice tell-tale signs of these probability coverage shaded areas

• the purple one for the martingale component $$m_t$$ grows with $$\sqrt{t}$$
• the green one for the stationary component $$s_t$$ converges to a constant band

### An associated multiplicative functional¶

Where $$\{y_t\}$$ is our additive functional, let $$M_t = \exp(y_t)$$

As mentioned above, the process $$\{M_t\}$$ is called a multiplicative functional

Corresponding to the additive decomposition described above we have the multiplicative decomposition of the $$M_t$$

$\frac{M_t}{M_0} = \exp (t \nu) \exp \Bigl(\sum_{j=1}^t H \cdot Z_j \Bigr) \exp \biggl( D'(I-A)^{-1} x_0 - D'(I-A)^{-1} x_t \biggr)$

or

$\frac{M_t}{M_0} = \exp\left( \tilde \nu t \right) \Biggl( \frac{\widetilde M_t}{\widetilde M_0}\Biggr) \left( \frac{\tilde e (X_0)} {\tilde e(x_t)} \right)$

where

$\tilde \nu = \nu + \frac{H \cdot H}{2} , \quad \widetilde M_t = \exp \biggl( \sum_{j=1}^t \biggl(H \cdot z_j -\frac{ H \cdot H }{2} \biggr) \biggr), \quad \widetilde M_0 =1$

and

$\tilde e(x) = \exp[g(x)] = \exp \bigl[ D' (I - A)^{-1} x \bigr]$

An instance of type AMF_LSS_VAR includes this associated multiplicative functional as an attribute

Let’s plot this multiplicative functional for our example

If you run the code that first simulated that example again and then the method call

plot_multiplicative(amf, T)


As before, when we plotted multiple realizations of a component in the 2nd, 3rd, and 4th panels, we also plotted population 95% confidence bands computed using the LSS type

Comparing this figure and the last also helps show how geometric growth differs from arithmetic growth

### A peculiar large sample property¶

Hansen and Sargent [HS17] (ch. 6) note that the martingale component $$\widetilde M_t$$ of the multiplicative decomposition has a peculiar property

• While $$E_0 \widetilde M_t = 1$$ for all $$t \geq 0$$, nevertheless $$\ldots$$
• As $$t \rightarrow +\infty$$, $$\widetilde M_t$$ converges to zero almost surely

The following simulation of many paths of $$\widetilde M_t$$ illustrates this property

srand(10021987)
plot_martingales(amf, 12000)


Here’s the resulting figure:

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