Question

how do you determine the order of Lags in ARMA model?

Answer 1

1. Take the ARMA (1,1) model, estimate the parameters via Maximum Likelihood
2. With this Maximum Likelihood, calculate the AIC of the ARMA (1,1)
3. Take the ARMA (1,2), ARMA (2,1) and the ARMA (2,2), estimate the parameters via Maximum Likelihood
4. Take these ML and calculate the AIC of the ARMA (1,2), ARMA (2,1) and the ARMA (2,2)
5. compare the AIC's of these models
6. If the AIC of either the ARMA (1,2), the ARMA (2,1) or the ARMA (2,2) is smaller than the one of the ARMA (1,1) take the next higher orders and repeat the procedure
7. Then if all higher orders have a greater AIC than one of the models with lower orders stop and thus the best model is the one with the smallest AIC
8. Compare the result with the ACF and see, if the result could be correct

Use any sophisticated tool like R or python to execute these steps