(b)

your answer. (2 marks) (ii) Compute the expectation and variance of Y. (6 marks) b) A researcher would like to find if there are any cointegrating relation- ships among daily German government bond yields from January 2002 to November 2014 for 5 different maturities: 3 months (YIELD3M), 1 year (YIELD1Y), 5 years (YIELDSY), 10 years (YIELD10Y) and 20 years (YIELD20Y). He performed a Johansen's cointegration Trace test and obtained the Eviews output in Figure 1. Sample (adjusted): 1/08/2002 11/05/2014 Included observations: 3347 after adjustments Trend assumption: Linear deterministic trend Series: YIELD3M YIELDIY YIELDSY YIELD10Y YIELD20Y Lags interval (in first differences): 1 to 4 Unrestricted Cointegration Rank Test (Trace) Hypothesized Trace 0.05 No. of CE(s) Eigenvalue Statistic Critical Value None 0.024209 165.2245 69.81889 At most 1 0.016292 83.20162 47.85613 At most 2 0.006157 28.22256 29.79707 At most 3 0.001799 7.551826 15.49471 At most 4 0.000455 1.524787 3.841465 Figure 1: Johansen's cointegration Trace test (i) Explain how you can use Figure 1 to determine the number of coin- tegrating relationships among the five German government bond yields. What is your conclusion? (5 marks) 4 ( Please turn over) (ii) Which model do you recommend the researcher use to examine the dynamics of the above yield system? Write down the model equation using generic notation. (4 marks) Total marks: (17 marks)