Section 1: True/False, & explain why in two or three sentences:
5. You are trying to forecast the quarterly US dollar-Euro exchange rate as a function of the dollar-Euro exchange rate in the previous quarter and the quarter before that. This is an autoregressive model with order 3.
We are here trying to forecast the exchange rate as a function of the values of two previous quarters.
An autoregressive model is a model where a time series value is regressed on previous values. Hence, this is an autoregressive model.
Now, let's check the order of the model. In general, in kth order autoregressive model, value at time 't' is predicted by values at time t-1, t-2... t-k. In this example, we are predicting the value by using the values at time t-1 and t-2. Hence, this is an autoregressive model of order 2 denoted by AR (2).
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