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Econ 123

Homework 3

(Due May 26th)

1. What is the Null hypothesis tested by: 

The DM Test?

The CW Test?

2. Find data on the Feds Funds Rate, the market yields on 1-year U.S. Treasuries, 5-year Treasuries, and 10-year Treasuries from FRED. Then, graph the Yield-Curve. What is the sign of the slope of the Yield-Curve? What does it mean?

3. Find the Feds Funds Future price for March 2023 in the CME https://www.cmegroup.com

a) What is the implied feds funds rate for June 14, 2023 derived from the futures price?

b) What is the implied probability that the Feds Funds Rate will increase 0.25 percentage

points from 5-5.25% to 5.25-5.50% in the next June meeting of the FOMC?

4. Read the WSJ article We May Be Getting Used to High Inflation, and That’s Bad News

https://www.wsj.com/articles/we-may-be-getting-used-to-high-inflation-and-thats-bad-news- d3a63e6f?st=og2i6erqh8m3lv7&reflink=desktopwebshare_permalink

Why is Greg Ip saying that a gradual reduction in inflation is bad news?

5. (Molodtsova and Papell paper exercise) Please submit both your R code and written explanation for this exercise.

Consider the following case:

(a) Smoothing with homogenous Coefficients (between domestic and foreign).

Write down the exchange rate forecast equation for the number of US dollars per British pound. What is the Diebold-Mariano-West (DMW) test hypothesis? What does it mean if we fail to reject the null? You can answer the second question in words or in mathematics, or both.

(b) Using R and the sample data provided in the ‘TA Notes’ folder, perform the ‘rolling-window regression’ on the exchange rate forecast equation you derived in (a) to produce forecasts. Using the values of the forecasts, conduct the DMW test. (As mentioned in the section, note that you only need to change some parts in the Step 2 of the R code provided in the ‘TA Notes’ folder.)   Interpret your results. Is the Taylor rule useful for exchange predicatibilty relative to the random walk?