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Question 5 Many time series used in finance are described as non-stationary series. a. What do we mean by non-stationary? Why is it important to test for non-stationarity and account for it in estimation? [4 marks] b. Three forms of standard Dickey-Fuller test are given below: A. Ayt = pyt-1 + ut B. Aye = a+pyt-1+ ut C. Aye = a + Bt + pyt-1 + ut Which of these forms would you use to test for non-stationarity in each of the following variables and why? Stock prices Stock returns iii. The residuals of an Engle-Granger test [2+2+2=6 marks] c. Consider the following data generating process for a series yt: y, = #+1.5y,_ +1, model for yt ? What most accurately describes the process for y,? How would you work with this [4 marks] d. What difficulties can arise when applying and interpreting Dickey-Fuller tests? Describe in detail another test which could be applied to test for non-stationarity. [3+3 = 6 marks] [Total of Question 5 = 20 marks)