【Data Analysis(10)】ARIMA-GARCH Model(Part 1)

TEJ 台灣經濟新報

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TEJ-API Financial Data Analysis

8 min readJan 11, 2022

Implement Python to construct time series model

Highlights

Difficulty：★★★☆☆
Introduction to Time Series Model
Reminder：In this article, we focus on data pre-processing and model test so as to make readers acquainted with the basic Time Series knowledge. Mathematics theorem of model and test will not be involved. However, it is required that readers know fundamental Statistics like P-value and so forth.

Preface

First of all, we need to declare the Time Series concept. It is a kind of data structure showing the development of historical data by the order of time. As for Time Series Model, it is applied to analyze time series data. Further, by this model, we manage to find high-likelihood trend and make forecasting.

Models we will implement are as follow：

Autoregressive Integrated Moving Average model, ARIMA

ARIMA is a fundamental time series model. Its parameters are Autoregression(AR), Differencing and Moving Average(MA).

AR：Indicates the situation of regression on historical data.
Integrated：Refers to how many order of differencing that observed data set should take so as to make it stationary.
MA：Represents the dependent relation between an observed data and residual from a moving average model derive from historical data.

General Autoregressive Conditional Heteroskedasticity model, GARCH

GARCH is used to analyze time series error. It is especially useful with application to measure volatility in investment domain. We will implement GARCH model to test residual from ARIMA so as to modify the error term. Parameters of GARCH is similar to that of ARIMA, but GARCH mainly focuses on error and variance. As for the numbers of (p,q), which is the amount we take from lagged data to fit GARCH, we will determine by ACF/PACF with the consideration of GARCH’s characteristics.

Process Outline:

Test whether input data is stationary or not.
Implement ARIMA with stationary data
Implement GARCH with residuals from ARIMA

Editing Environment and Modules Required

MacOS & Jupyter Notebook

# Basic
import numpy as np
import pandas as pd# Graph
import matplotlib.pyplot as plt
%matplotlib inline
import seaborn as sns
sns.set()# TEJ API
import tejapi
tejapi.ApiConfig.api_key = 'Your Key'
tejapi.ApiConfig.ignoretz = True

Database

Security Transaction Data Table：Listed securities with unadjusted price and index. Code is ‘TWN/EWPRCD’.

Return Information Data Table：Listed securities with daily return. Code is ‘TWN/EWPRCD2’.

Data Selection

0050.TW is target index in this article.

data_price = tejapi.get('TWN/EWPRCD', 
                 coid= '0050', # 台灣50
                 mdate={'gte': '2003-01-01', 'lte':'2021-12-24'},
                 opts={'columns': ['coid', 'mdate', 'close_d', ]},
                 chinese_column_name=True,
                 paginate=True)data_price = data_price.set_index('日期')# import chinese into matplotlib
plt.rcParams['font.sans-serif'] = ['Arial Unicode MS']# Graph 0050’s price trend
fig, ax = plt.subplots(figsize = (10, 5))
plt.plot(data_price['收盤價'], label = '0050-price')
plt.title('0050收盤價')
plt.legend()

Based on above chart, it is clear that there exists a trend with time elapse. This situation is caused by that price data is non-stationary. Therefore, we conduct Augmented Dickey-Fuller(ADF) Test to check whether unit root exists in the series or not. If unit root truly exists, we would “difference” raw data to convert non-stationary to stationary. We will check this by P-value.

from statsmodels.tsa.stattools import adfuller# take P-value term form ADF report 
price_p_value = adfuller(data_price['收盤價'])[1]# set the standard to judge stantionary 
if price_p_value > 0.05:
    print('Nonstationary')
else:
    print('Stationary')

H0：Data is Non-stationary
H1：Data is Stationary

According to the result of ADF test, it is assured that price data is non-stationary. Hence, we cannot take price to fit following models.

Reason to declare the importance of being stationary or not is as follow：

If data is non-stationary, its trend would be random walk. As a result, it is just a coincidence that data fits model well. It is non-sense to prove how-well a model performs. After all, model cannot interpret a random walk.

As know that price is not eligible for fitting model, we import “Return ”(Graph and ADF process is available in the Source Code)

data_ret = tejapi.get('TWN/EWPRCD2', 
               coid= '0050', # 台灣50
               mdate={'gte': '2003-01-01', 'lte':'2021-12-24'},
               opts={'col     umns': ['coid', 'mdate', 'roia', ]},
               chinese_column_name=True,
               paginate=True)
data_ret = data_ret.set_index('日期')

According to the result of ADF test, it is assured that return data is stationary. Hence, we can take price to fit following models.

Data Split

train_date = data.index.get_level_values('日期') <= '2020-12-31'
train_data = data[train_date]
test_data = data[~train_date]

train_data：Serve as the term to construct model
test_data： Serve as the term to compare with the post-modelling prediction

This article would only focus on data pre-processing and modelling, so we would apply test_data only in following article.

ARIMA Model

We apply pmdarima to find best-fitted parameter set.

import pmdarima as pmd
pmd_mdl = pmd.auto_arima(train_data['日報酬率(%)'], stationary = True)
pmd_mdl.summary()

According to above table, we would know that the best-fitted parameter set is (2, 0, 2). To boot, it is clear that every P-value is smaller than the strictest level, 0.01, so the significance of every coefficient is certain.

Note：If you notice that the name of model is SARIMAX, instead of ARIMA, it is nothing to worry about. SARIMAX is the default set of pmdarima, but the process remains ARIMA. We import statsmodel package to check this result.

from statsmodels.tsa.arima.model import ARIMAmodel = ARIMA(train_data['日報酬率(%)'], order = (2, 0, 2))
stats_mdl = model.fit() 
print(stats_mdl.summary())

Observing the ARIMA report by statsmodels, we know the difference of fitting level(AIC & BIC) between pmdarima and statsmodels is tiny. As for the coefficient estimation table, the significance level is identical as well, though the coefficient and standard error terms differs a little.

ARIMA Diagnosis

Residual diagnosis

stats_mdl.plot_diagnostics(figsize = (15, 10))
plt.show()

There is no apparent trend of residual by observing left-top chart. However, the histogram(right-top) and Normal Q-Q plot(left-bottom) make us conclude that the normality of model residual is not sufficient, which indicates that ARIMA’s residual still contains some explanatory variable. We would conduct white noise test to verify it.

White Noise Test

By Ljung-Box Test, we would know whether ARIMA’s residual is random or not. If the result shows that residual is white noise(random), we could conclude that ARIMA is fitted well. However, if residual is not white noise, we would further implement GARCH to interpret the explanatory variance inside error term.

from statsmodels.stats.diagnostic import acorr_ljungboxarima_resid = pmd_mdl.arima_res_.residwhite_noise_arima = acorr_ljungbox(arima_resid, lags = [10], return_df=True)
white_noise_arima

H0：Error term is white noise
H1：Error term is not white noise

Test result make us know the error term is not white noise(P-value < 0.05). Therefore, we would conduct GARCH to fit ARIMA’s residual.

GARCH Model

ARCH Effect Test

In spite of proof of that ARIMA’s residual is not random, we cannot prove that term exists heteroskedasticity. We would conduct ARCH Effect Test to confirm that.

from statsmodels.stats.diagnostic import het_archLM_pvalue = het_arch(arima_resid, ddof = 4)[1]
print('LM-test-Pvalue:', '{:.5f}'.format(LM_pvalue))

H0： ARCH Effect not exists
H1：ARCH Effect exists

By P-value of the test, we would reject H0. Namely, we can apply GARCH to fit ARIMA’s residual.

ACF / PACF

Autocorrelation Function, ACF：Measure correlation between series and its lagged values.
Partial Autocorrelation Function, PACF：Find correlation of residuals with with the following lagged value.

import statsmodels.graphics.tsaplots as sgt
fig, ax = plt.subplots(1, 2, figsize = (18,5))sgt.plot_acf(arima_resid**2, zero = False, lags = 40, ax=ax[0])
sgt.plot_pacf(arima_resid**2, zero = False, lags = 40, ax=ax[1])plt.show()

Above chart makes us know that squared-residual’s autoregression is significant. Synthesizing PACF(right) and GARCH’s mathematics structure, we assume that GARCH’s parameter set (p,q) are (1,1), (2,1), (1,2) and (2,2). After compare model’s goodness of fit and significance of those sets, we determine which set to use. In case of the redundant content, we only display the best-fitted set, (1,1).

Note：GARCH’s mathematics structure contains all the historical data and the weight becomes lower as the time farer.

from arch import arch_modelmdl_garch = arch_model(pmd_residual, vol = 'GARCH', p = 1, q = 1)
res_fit = mdl_garch.fit()
res_fit.summary()

According to above tables, we understand that every coefficient is significant. The following is diagnosis of GARCH model.

GARCH Diagnosis(Programming is available in the Source Code)

Residual diagnosis

Observing above chart, we can conclude that there is no trend for GARCH residual. On top of that, based on residual histogram and Normal Q-Q plot show the normality. Again, we apply white noise test to further verify that residual is random.

White Noise Test

Test result make us know the error term is white noise(P-value > 0.05). Therefore, no explanatory variable can be taken. The residual is random.

Conclusion

So far, we have gone through the whole process of modeling. Firstly, verify non-stationary and stationary data. Secondly, fit ARIMA model with return data. Lastly, fit GARCH model with residual term. You may notice the process of Statistics test is very strict. This article, however, in order to make readers acquainted with whole process quickly, spare mathematics theorems behind models and tests.

The above implementation of time series model is what we expect readers to understand. Following article would discuss how to apply the models to forecasting. Last but not least, credit to database of TEJ, we can easily conduct tests and models. As a result, welcome to purchase the plan offered in TEJ E-Shop to find the data you need.