# Covariance Stationary Processes¶

## Overview¶

In this lecture we study covariance stationary linear stochastic processes, a class of models routinely used to study economic and financial time series

This class has the advantange of being

1. simple enough to be described by an elegant and comprehensive theory
2. relatively broad in terms of the kinds of dynamics it can represent

We consider these models in both the time and frequency domain

### ARMA Processes¶

We will focus much of our attention on linear covariance stationary models with a finite number of parameters

In particular, we will study stationary ARMA processes, which form a cornerstone of the standard theory of time series analysis

It’s well known that every ARMA processes can be represented in linear state space form

However, ARMA have some important structure that makes it valuable to study them separately

### Spectral Analysis¶

Analysis in the frequency domain is also called spectral analysis

In essence, spectral analysis provides an alternative representation of the autocovariance of a covariance stationary process

Having a second representation of this important object

• shines new light on the dynamics of the process in question
• allows for a simpler, more tractable representation in certain important cases

The famous Fourier transform and its inverse are used to map between the two representations

## Introduction¶

Consider a sequence of random variables $$\{ X_t \}$$ indexed by $$t \in \mathbb Z$$ and taking values in $$\mathbb R$$

Thus, $$\{ X_t \}$$ begins in the infinite past and extends to the infinite future — a convenient and standard assumption

As in other fields, successful economic modeling typically requires identifying some deep structure in this process that is relatively constant over time

If such structure can be found, then each new observation $$X_t, X_{t+1},\ldots$$ provides additional information about it — which is how we learn from data

For this reason, we will focus in what follows on processes that are stationary — or become so after some transformation (differencing, cointegration, etc.)

### Definitions¶

A real-valued stochastic process $$\{ X_t \}$$ is called covariance stationary if

1. Its mean $$\mu := \mathbb E X_t$$ does not depend on $$t$$
2. For all $$k$$ in $$\mathbb Z$$, the $$k$$-th autocovariance $$\gamma(k) := \mathbb E (X_t - \mu)(X_{t + k} - \mu)$$ is finite and depends only on $$k$$

The function $$\gamma \colon \mathbb Z \to \mathbb R$$ is called the autocovariance function of the process

Throughout this lecture, we will work exclusively with zero-mean (i.e., $$\mu = 0$$) covariance stationary processes

The zero-mean assumption costs nothing in terms of generality, since working with non-zero-mean processes involves no more than adding a constant

### Example 1: White Noise¶

Perhaps the simplest class of covariance stationary processes is the white noise processes

A process $$\{ \epsilon_t \}$$ is called a white noise process if

1. $$\mathbb E \epsilon_t = 0$$
2. $$\gamma(k) = \sigma^2 \mathbf 1\{k = 0\}$$ for some $$\sigma > 0$$

(Here $$\mathbf 1\{k = 0\}$$ is defined to be 1 if $$k = 0$$ and zero otherwise)

### Example 2: General Linear Processes¶

From the simple building block provided by white noise, we can construct a very flexible family of covariance stationary processes — the general linear processes

(1)$X_t = \sum_{j=0}^{\infty} \psi_j \epsilon_{t-j}, \qquad t \in \mathbb Z$

where

• $$\{\epsilon_t\}$$ is white noise
• $$\{\psi_t\}$$ is a square summable sequence in $$\mathbb R$$ (that is, $$\sum_{t=0}^{\infty} \psi_t^2 < \infty$$)

The sequence $$\{\psi_t\}$$ is often called a linear filter

With some manipulations it is possible to confirm that the autocovariance function for (1) is

(2)$\gamma(k) = \sigma^2 \sum_{j=0}^{\infty} \psi_j \psi_{j+k}$

By the Cauchy-Schwartz inequality one can show that the last expression is finite. Clearly it does not depend on $$t$$

### Wold’s Decomposition¶

Remarkably, the class of general linear processes goes a long way towards describing the entire class of zero-mean covariance stationary processes

In particular, Wold’s theorem states that every zero-mean covariance stationary process $$\{X_t\}$$ can be written as

$X_t = \sum_{j=0}^{\infty} \psi_j \epsilon_{t-j} + \eta_t$

where

• $$\{\epsilon_t\}$$ is white noise
• $$\{\psi_t\}$$ is square summable
• $$\eta_t$$ can be expressed as a linear function of $$X_{t-1}, X_{t-2},\ldots$$ and is perfectly predictable over arbitrarily long horizons

For intuition and further discussion, see [Sar87], p. 286

### AR and MA¶

General linear processes are a very broad class of processes, and it often pays to specialize to those for which there exists a representation having only finitely many parameters

(In fact, experience shows that models with a relatively small number of parameters typically perform better than larger models, especially for forecasting)

One very simple example of such a model is the AR(1) process

(3)$\begin{split}X_t = \phi X_{t-1} + \epsilon_t \quad \text{where} \quad | \phi | < 1 \quad \text{and } \{ \epsilon_t \} \text{ is white noise}\end{split}$

By direct substitution, it is easy to verify that $$X_t = \sum_{j=0}^{\infty} \phi^j \epsilon_{t-j}$$

Hence $$\{X_t\}$$ is a general linear process

Applying (2) to the previous expression for $$X_t$$, we get the AR(1) autocovariance function

(4)$\gamma(k) = \phi^k \frac{\sigma^2}{1 - \phi^2}, \qquad k = 0, 1, \ldots$

The next figure plots this function for $$\phi = 0.8$$ and $$\phi = -0.8$$ with $$\sigma = 1$$

Another very simple process is the MA(1) process

$X_t = \epsilon_t + \theta \epsilon_{t-1}$

You will be able to verify that

$\begin{split}\gamma(0) = \sigma^2 (1 + \theta^2), \quad \gamma(1) = \sigma^2 \theta, \quad \text{and} \quad \gamma(k) = 0 \quad \forall \, k > 1\end{split}$

The AR(1) can be generalized to an AR($$p$$) and likewise for the MA(1)

Putting all of this together, we get the

### ARMA Processes¶

A stochastic process $$\{X_t\}$$ is called an autoregressive moving average process, or ARMA($$p,q$$), if it can be written as

(5)$X_t = \phi_1 X_{t-1} + \cdots + \phi_p X_{t-p} + \epsilon_t + \theta_1 \epsilon_{t-1} + \cdots + \theta_q \epsilon_{t-q}$

where $$\{ \epsilon_t \}$$ is white noise

There is an alternative notation for ARMA processes in common use, based around the lag operator $$L$$

Def. Given arbitrary variable $$Y_t$$, let $$L^k Y_t := Y_{t-k}$$

It turns out that

• lag operators can lead to very succinct expressions for linear stochastic processes
• algebraic manipulations treating the lag operator as an ordinary scalar often are legitimate

Using $$L$$, we can rewrite (5) as

(6)$L^0 X_t - \phi_1 L^1 X_t - \cdots - \phi_p L^p X_t = L^0 \epsilon_t + \theta_1 L^1 \epsilon_t + \cdots + \theta_q L^q \epsilon_t$

If we let $$\phi(z)$$ and $$\theta(z)$$ be the polynomials

(7)$\phi(z) := 1 - \phi_1 z - \cdots - \phi_p z^p \quad \text{and} \quad \theta(z) := 1 + \theta_1 z + \cdots + \theta_q z^q$

then (6) simplifies further to

(8)$\phi(L) X_t = \theta(L) \epsilon_t$

In what follows we always assume that the roots of the polynomial $$\phi(z)$$ lie outside the unit circle in the complex plane

This condition is sufficient to guarantee that the ARMA($$p,q$$) process is convariance stationary

In fact it implies that the process falls within the class of general linear processes described above

That is, given an ARMA($$p,q$$) process $$\{ X_t \}$$ satisfying the unit circle condition, there exists a square summable sequence $$\{\psi_t\}$$ with $$X_t = \sum_{j=0}^{\infty} \psi_j \epsilon_{t-j}$$ for all $$t$$

The sequence $$\{\psi_t\}$$ can be obtained by a recursive procedure outlined on page 79 of [CC08]

In this context, the function $$t \mapsto \psi_t$$ is often called the impulse response function

## Spectral Analysis¶

Autocovariance functions provide a great deal of infomation about covariance stationary processes

In fact, for zero-mean Gaussian processes, the autocovariance function characterizes the entire joint distribution

Even for non-Gaussian processes, it provides a significant amount of information

It turns out that there is an alternative representation of the autocovariance function of a covariance stationary process, called the spectral density

At times, the spectral density is easier to derive, easier to manipulate and provides additional intuition

### Complex Numbers¶

Before discussing the spectral density, we invite you to recall the main properties of complex numbers (or skip to the next section)

It can be helpful to remember that, in a formal sense, complex numbers are just points $$(x, y) \in \mathbb R^2$$ endowed with a specific notion of multiplication

When $$(x, y)$$ is regarded as a complex number, $$x$$ is called the real part and $$y$$ is called the imaginary part

The modulus or absolute value of a complex number $$z = (x, y)$$ is just its Euclidean norm in $$\mathbb R^2$$, but is usually written as $$|z|$$ instead of $$\|z\|$$

The product of two complex numbers $$(x, y)$$ and $$(u, v)$$ is defined to be $$(xu - vy, xv + yu)$$, while addition is standard pointwise vector addition

When endowed with these notions of multiplication and addition, the set of complex numbers forms a field — addition and multiplication play well together, just as they do in $$\mathbb R$$

The complex number $$(x, y)$$ is often written as $$x + i y$$, where $$i$$ is called the imaginary unit, and is understood to obey $$i^2 = -1$$

The $$x + i y$$ notation can be thought of as an easy way to remember the definition of multiplication given above, because, proceeding naively,

$(x + i y) (u + i v) = xu - yv + i (xv + yu)$

Converted back to our first notation, this becomes $$(xu - vy, xv + yu)$$, which is the same as the product of $$(x, y)$$ and $$(u, v)$$ from our previous definition

Complex numbers are also sometimes expressed in their polar form $$r e^{i \omega}$$, which should be interpreted as

$r e^{i \omega} := r (\cos(\omega) + i \sin(\omega))$

### Spectral Densities¶

Let $$\{ X_t \}$$ be a covariance stationary process with autocovariance function $$\gamma$$ satisfying $$\sum_{k} \gamma(k)^2 < \infty$$

The spectral density $$f$$ of $$\{ X_t \}$$ is defined as the discrete time Fourier transform of its autocovariance function $$\gamma$$

$f(\omega) := \sum_{k \in \mathbb Z} \gamma(k) e^{-i \omega k}, \qquad \omega \in \mathbb R$

(Some authors normalize the expression on the right by constants such as $$1/\pi$$ — the chosen convention makes little difference provided you are consistent)

Using the fact that $$\gamma$$ is even, in the sense that $$\gamma(t) = \gamma(-t)$$ for all $$t$$, you should be able to show that

(9)$f(\omega) = \gamma(0) + 2 \sum_{k \geq 1} \gamma(k) \cos(\omega k)$

It is not difficult to confirm that $$f$$ is

• real-valued
• even ($$f(\omega) = f(-\omega)$$ ), and
• $$2\pi$$-periodic, in the sense that $$f(2\pi + \omega) = f(\omega)$$ for all $$\omega$$

It follows that the values of $$f$$ on $$[0, \pi]$$ determine the values of $$f$$ on all of $$\mathbb R$$ — the proof is an exercise

For this reason it is standard to plot the spectral density only on the interval $$[0, \pi]$$

### Example 1: White Noise¶

Consider a white noise process $$\{\epsilon_t\}$$ with standard deviation $$\sigma$$

It is simple to check that in this case we have $$f(\omega) = \sigma^2$$. In particular, $$f$$ is a constant function

As we will see, this can be interpreted as meaning that “all frequencies are equally present”

(White light has this property when frequency refers to the visible spectrum, a connection that provides the origins of the term “white noise”)

### Example 2: AR and MA and ARMA¶

It is an exercise to show that the MA(1) process $$X_t = \theta \epsilon_{t-1} + \epsilon_t$$ has spectral density

(10)$f(\omega) = \sigma^2 ( 1 + 2 \theta \cos(\omega) + \theta^2 )$

With a bit more effort, it’s possible to show (see, e.g., p. 261 of [Sar87]) that the spectral density of the AR(1) process $$X_t = \phi X_{t-1} + \epsilon_t$$ is

(11)$f(\omega) = \frac{\sigma^2}{ 1 - 2 \phi \cos(\omega) + \phi^2 }$

More generally, it can be shown that the spectral density of the ARMA process (5) is

(12)$f(\omega) = \left| \frac{\theta(e^{i\omega})}{\phi(e^{i\omega})} \right|^2 \sigma^2$

where

• $$\sigma$$ is the standard deviation of the white noise process $$\{\epsilon_t\}$$
• the polynomials $$\phi(\cdot)$$ and $$\theta(\cdot)$$ are as defined in (7)

The derivation of (12) uses the fact that convolutions become products under Fourier transformations

The proof is elegant and can be found in many places — see, for example, [Sar87], chapter 11, section 4

It’s a nice exercise to verify that (10) and (11) are indeed special cases of (12)

### Interpreting the Spectral Density¶

Plotting (11) reveals the shape of the spectral density for the AR(1) model when $$\phi$$ takes the values 0.8 and -0.8 respectively

These spectral densities correspond to the autocovariance functions for the AR(1) process shown above

Informally, we think of the spectral density as being large at those $$\omega \in [0, \pi]$$ such that the autocovariance function exhibits significant cycles at this “frequency”

To see the idea, let’s consider why, in the lower panel of the preceding figure, the spectral density for the case $$\phi = -0.8$$ is large at $$\omega = \pi$$

Recall that the spectral density can be expressed as

(13)$f(\omega) = \gamma(0) + 2 \sum_{k \geq 1} \gamma(k) \cos(\omega k) = \gamma(0) + 2 \sum_{k \geq 1} (-0.8)^k \cos(\omega k)$

When we evaluate this at $$\omega = \pi$$, we get a large number because $$\cos(\pi k)$$ is large and positive when $$(-0.8)^k$$ is positive, and large in absolute value and negative when $$(-0.8)^k$$ is negative

Hence the product is always large and positive, and hence the sum of the products on the right-hand side of (13) is large

These ideas are illustrated in the next figure, which has $$k$$ on the horizontal axis (click to enlarge)

On the other hand, if we evaluate $$f(\omega)$$ at $$\omega = \pi / 3$$, then the cycles are not matched, the sequence $$\gamma(k) \cos(\omega k)$$ contains both positive and negative terms, and hence the sum of these terms is much smaller

In summary, the spectral density is large at frequencies $$\omega$$ where the autocovariance function exhibits cycles

### Inverting the Transformation¶

We have just seen that the spectral density is useful in the sense that it provides a frequency-based perspective on the autocovariance structure of a covariance stationary process

Another reason that the spectral density is useful is that it can be “inverted” to recover the autocovariance function via the inverse Fourier transform

In particular, for all $$k \in \mathbb Z$$, we have

(14)$\gamma(k) = \frac{1}{2 \pi} \int_{-\pi}^{\pi} f(\omega) e^{i \omega k} d\omega$

This is convenient in situations where the spectral density is easier to calculate and manipulate than the autocovariance function

(For example, the expression (12) for the ARMA spectral density is much easier to work with than the expression for the ARMA autocovariance)

### Mathematical Theory¶

This section is loosely based on [Sar87], p. 249-253, and included for those who

• would like a bit more insight into spectral densities
• and have at least some background in Hilbert space theory

Others should feel free to skip to the next section — none of this material is necessary to progress to computation

Recall that every separable Hilbert space $$H$$ has a countable orthonormal basis $$\{ h_k \}$$

The nice thing about such a basis is that every $$f \in H$$ satisfies

(15)$f = \sum_k \alpha_k h_k \quad \text{where} \quad \alpha_k := \langle f, h_k \rangle$

where $$\langle \cdot, \cdot \rangle$$ denotes the inner product in $$H$$

Thus, $$f$$ can be represented to any degree of precision by linearly combining basis vectors

The scalar sequence $$\alpha = \{\alpha_k\}$$ is called the Fourier coefficients of $$f$$, and satisfies $$\sum_k |\alpha_k|^2 < \infty$$

In other words, $$\alpha$$ is in $$\ell_2$$, the set of square summable sequences

Consider an operator $$T$$ that maps $$\alpha \in \ell_2$$ into its expansion $$\sum_k \alpha_k h_k \in H$$

The Fourier coefficients of $$T\alpha$$ are just $$\alpha = \{ \alpha_k \}$$, as you can verify by confirming that $$\langle T \alpha, h_k \rangle = \alpha_k$$

Using elementary results from Hilbert space theory, it can be shown that

• $$T$$ is one-to-one — if $$\alpha$$ and $$\beta$$ are distinct in $$\ell_2$$, then so are their expansions in $$H$$
• $$T$$ is onto — if $$f \in H$$ then its preimage in $$\ell_2$$ is the sequence $$\alpha$$ given by $$\alpha_k = \langle f, h_k \rangle$$
• $$T$$ is a linear isometry — in particular $$\langle \alpha, \beta \rangle = \langle T\alpha, T\beta \rangle$$

Summarizing these results, we say that any separable Hilbert space is isometrically isomorphic to $$\ell_2$$

In essence, this says that each separable Hilbert space we consider is just a different way of looking at the fundamental space $$\ell_2$$

With this in mind, let’s specialize to a setting where

• $$\gamma \in \ell_2$$ is the autocovariance function of a covariance stationary process, and $$f$$ is the spectral density
• $$H = L_2$$, where $$L_2$$ is the set of square summable functions on the interval $$[-\pi, \pi]$$, with inner product $$\langle g, h \rangle = \int_{-\pi}^{\pi} g(\omega) h(\omega) d \omega$$
• $$\{h_k\} =$$ the orthonormal basis for $$L_2$$ given by the set of trigonometric functions
$h_k(\omega) = \frac{e^{i \omega k}}{\sqrt{2 \pi}}, \quad k \in \mathbb Z, \quad \omega \in [-\pi, \pi]$

Using the definition of $$T$$ from above and the fact that $$f$$ is even, we now have

(16)$T \gamma = \sum_{k \in \mathbb Z} \gamma(k) \frac{e^{i \omega k}}{\sqrt{2 \pi}} = \frac{1}{\sqrt{2 \pi}} f(\omega)$

In other words, apart from a scalar multiple, the spectral density is just an transformation of $$\gamma \in \ell_2$$ under a certain linear isometry — a different way to view $$\gamma$$

In particular, it is an expansion of the autocovariance function with respect to the trigonometric basis functions in $$L_2$$

As discussed above, the Fourier coefficients of $$T \gamma$$ are given by the sequence $$\gamma$$, and, in particular, $$\gamma(k) = \langle T \gamma, h_k \rangle$$

Transforming this inner product into its integral expression and using (16) gives (14), justifying our earlier expression for the inverse transform

## Implementation¶

Most code for working with covariance stationary models deals with ARMA models

Julia code for studying ARMA models can be found in the DSP.jl package

Since this code doesn’t quite cover our needs — particularly vis-a-vis spectral analysis — we’ve put together the module arma.jl, which is part of QuantEcon.jl package.

The module provides functions for mapping ARMA($$p,q$$) models into their

1. impulse response function
2. simulated time series
3. autocovariance function
4. spectral density

In additional to individual plots of these entities, we provide functionality to generate 2x2 plots containing all this information

In other words, we want to replicate the plots on pages 68–69 of [LS12]

Here’s an example corresponding to the model $$X_t = 0.5 X_{t-1} + \epsilon_t - 0.8 \epsilon_{t-2}$$

### Code¶

For interest’s sake, arma.jl is printed below

#=

@authors: John Stachurski
Date: Thu Aug 21 11:09:30 EST 2014

Provides functions for working with and visualizing scalar ARMA processes.
Ported from Python module quantecon.arma, which was written by Doc-Jin Jang,
Jerry Choi, Thomas Sargent and John Stachurski

References
----------

http://quant-econ.net/jl/arma.html

=#

"""
Represents a scalar ARMA(p, q) process

If phi and theta are scalars, then the model is
understood to be

X_t = phi X_{t-1} + epsilon_t + theta epsilon_{t-1}

where epsilon_t is a white noise process with standard
deviation sigma.

If phi and theta are arrays or sequences,
then the interpretation is the ARMA(p, q) model

X_t = phi_1 X_{t-1} + ... + phi_p X_{t-p} +
epsilon_t + theta_1 epsilon_{t-1} + ...  +
theta_q epsilon_{t-q}

where

* phi = (phi_1, phi_2,..., phi_p)
* theta = (theta_1, theta_2,..., theta_q)
* sigma is a scalar, the standard deviation of the white noise

##### Fields

- phi::Vector : AR parameters phi_1, ..., phi_p
- theta::Vector : MA parameters theta_1, ..., theta_q
- p::Integer : Number of AR coefficients
- q::Integer : Number of MA coefficients
- sigma::Real : Standard deviation of white noise
- ma_poly::Vector : MA polynomial --- filtering representatoin
- ar_poly::Vector : AR polynomial --- filtering representation

##### Examples

julia
using QuantEcon
phi = 0.5
theta = [0.0, -0.8]
sigma = 1.0
lp = ARMA(phi, theta, sigma)
require(joinpath(dirname(@__FILE__),"..", "examples", "arma_plots.jl"))

"""
type ARMA
phi::Vector      # AR parameters phi_1, ..., phi_p
theta::Vector    # MA parameters theta_1, ..., theta_q
p::Integer       # Number of AR coefficients
q::Integer       # Number of MA coefficients
sigma::Real      # Variance of white noise
ma_poly::Vector  # MA polynomial --- filtering representatoin
ar_poly::Vector  # AR polynomial --- filtering representation
end

# constructors to coerce phi/theta to vectors
ARMA(phi::Real, theta::Real, sigma::Real) = ARMA([phi;], [theta;], sigma)
ARMA(phi::Real, theta::Vector, sigma::Real) = ARMA([phi;], theta, sigma)
ARMA(phi::Vector, theta::Real, sigma::Real) = ARMA(phi, [theta;], sigma)

function ARMA(phi::AbstractVector, theta::AbstractVector=[0.0], sigma::Real=1.0)
# == Record dimensions == #
p = length(phi)
q = length(theta)

# == Build filtering representation of polynomials == #
ma_poly = [1.0; theta]
ar_poly = [1.0; -phi]
return ARMA(phi, theta, p, q, sigma, ma_poly, ar_poly)
end

"""
Compute the spectral density function.

The spectral density is the discrete time Fourier transform of the
autocovariance function. In particular,

f(w) = sum_k gamma(k) exp(-ikw)

where gamma is the autocovariance function and the sum is over
the set of all integers.

##### Arguments

- arma::ARMA: Instance of ARMA type
- ;two_pi::Bool(true): Compute the spectral density function over [0, pi] if
false and [0, 2 pi] otherwise.
- ;res(1200) : If res is a scalar then the spectral density is computed at
res frequencies evenly spaced around the unit circle, but if res is an array
then the function computes the response at the frequencies given by the array

##### Returns
- w::Vector{Float64}: The normalized frequencies at which h was computed, in
- spect::Vector{Float64} : The frequency response
"""
function spectral_density(arma::ARMA; res=1200, two_pi::Bool=true)
# Compute the spectral density associated with ARMA process arma
wmax = two_pi ? 2pi : pi
w = linspace(0, wmax, res)
tf = TFFilter(reverse(arma.ma_poly), reverse(arma.ar_poly))
h = freqz(tf, w)
spect = arma.sigma^2 * abs(h).^2
return w, spect
end

"""
Compute the autocovariance function from the ARMA parameters
over the integers range(num_autocov) using the spectral density
and the inverse Fourier transform.

##### Arguments

- arma::ARMA: Instance of ARMA type
- ;num_autocov::Integer(16) : The number of autocovariances to calculate

"""
function autocovariance(arma::ARMA; num_autocov::Integer=16)
# Compute the autocovariance function associated with ARMA process arma
# Computation is via the spectral density and inverse FFT
(w, spect) = spectral_density(arma)
acov = real(Base.ifft(spect))
# num_autocov should be <= len(acov) / 2
return acov[1:num_autocov]
end

"""
Get the impulse response corresponding to our model.

##### Arguments

- arma::ARMA: Instance of ARMA type
- ;impulse_length::Integer(30): Length of horizon for calucluating impulse
reponse. Must be at least as long as the p fields of arma

##### Returns

- psi::Vector{Float64}: psi[j] is the response at lag j of the impulse
response. We take psi[1] as unity.

"""
function impulse_response(arma::ARMA; impulse_length=30)
# Compute the impulse response function associated with ARMA process arma
err_msg = "Impulse length must be greater than number of AR coefficients"
@assert impulse_length >= arma.p err_msg
# == Pad theta with zeros at the end == #
theta = [arma.theta; zeros(impulse_length - arma.q)]
psi_zero = 1.0
psi = Array(Float64, impulse_length)
for j = 1:impulse_length
psi[j] = theta[j]
for i = 1:min(j, arma.p)
psi[j] += arma.phi[i] * (j-i > 0 ? psi[j-i] : psi_zero)
end
end
return [psi_zero; psi[1:end-1]]
end

"""
Compute a simulated sample path assuming Gaussian shocks.

##### Arguments

- arma::ARMA: Instance of ARMA type
- ;ts_length::Integer(90): Length of simulation
- ;impulse_length::Integer(30): Horizon for calculating impulse response
(see also docstring for impulse_response)

##### Returns

- X::Vector{Float64}: Simulation of the ARMA model arma

"""
function simulation(arma::ARMA; ts_length=90, impulse_length=30)
# Simulate the ARMA process arma assuing Gaussian shocks
J = impulse_length
T = ts_length
psi = impulse_response(arma, impulse_length=impulse_length)
epsilon = arma.sigma * randn(T + J)
X = Array(Float64, T)
for t=1:T
X[t] = dot(epsilon[t:J+t-1], psi)
end
return X
end


Here’s an example of usage

julia> using QuantEcon

julia> using QuantEcon

julia> phi = 0.5;

julia> theta = [0, -0.8];

julia> lp = ARMA(phi, theta);



### Explanation¶

The call

lp = ARMA(phi, theta, sigma)


creates an instance lp that represents the ARMA($$p, q$$) model

$X_t = \phi_1 X_{t-1} + ... + \phi_p X_{t-p} + \epsilon_t + \theta_1 \epsilon_{t-1} + ... + \theta_q \epsilon_{t-q}$

If phi and theta are arrays or sequences, then the interpretation will be

• phi holds the vector of parameters $$(\phi_1, \phi_2,..., \phi_p)$$
• theta holds the vector of parameters $$(\theta_1, \theta_2,..., \theta_q)$$

The parameter sigma is always a scalar, the standard deviation of the white noise

We also permit phi and theta to be scalars, in which case the model will be interpreted as

$X_t = \phi X_{t-1} + \epsilon_t + \theta \epsilon_{t-1}$

The two numerical packages most useful for working with ARMA models are DSP.jl and the fft routine in Julia

### Computing the Autocovariance Function¶

As discussed above, for ARMA processes the spectral density has a simple representation that is relatively easy to calculate

Given this fact, the easiest way to obtain the autocovariance function is to recover it from the spectral density via the inverse Fourier transform

Here we use Julia’s Fourier transform routine fft, which wraps a standard C-based package called FFTW

A look at the fft documentation shows that the inverse transform ifft takes a given sequence $$A_0, A_1, \ldots, A_{n-1}$$ and returns the sequence $$a_0, a_1, \ldots, a_{n-1}$$ defined by

$a_k = \frac{1}{n} \sum_{t=0}^{n-1} A_t e^{ik 2\pi t / n}$

Thus, if we set $$A_t = f(\omega_t)$$, where $$f$$ is the spectral density and $$\omega_t := 2 \pi t / n$$, then

$a_k = \frac{1}{n} \sum_{t=0}^{n-1} f(\omega_t) e^{i \omega_t k} = \frac{1}{2\pi} \frac{2 \pi}{n} \sum_{t=0}^{n-1} f(\omega_t) e^{i \omega_t k}, \qquad \omega_t := 2 \pi t / n$

For $$n$$ sufficiently large, we then have

$a_k \approx \frac{1}{2\pi} \int_0^{2 \pi} f(\omega) e^{i \omega k} d \omega = \frac{1}{2\pi} \int_{-\pi}^{\pi} f(\omega) e^{i \omega k} d \omega$

(You can check the last equality)

In view of (14) we have now shown that, for $$n$$ sufficiently large, $$a_k \approx \gamma(k)$$ — which is exactly what we want to compute

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