# 1 Cholesky Decomposition Correlated Five Dimensional Multivariate Normal Shock

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Generate variance-covariance matrix from correlation and standard deviation. Draw five correlated normal shocks using the MVNRND function. Draw five correlated normal shocks from uniform random variables using Cholesky Decomposition.

## 1.1 Correlation and Standard Deviations to Variance Covariance Matrix

Given correlations and standard deviations, what is the variance and covariance matrix? Assume mean 0. The first three variables are correlated, the final two are iid.

First the ingredients:

``````% mean array
ar_mu = [0,0,0,0,0];
% standard deviations
ar_sd = [0.3301, 0.3329, 0.3308, 2312, 13394];
% correlations
mt_cor = ...
[1,0.1226,0.0182,0,0;...
0.1226,1,0.4727,0,0;...
0.0182,0.4727,1,0,0;...
0,0,0,1,0;...
0,0,0,0,1];
% show
disp(mt_cor);

1.0000    0.1226    0.0182         0         0
0.1226    1.0000    0.4727         0         0
0.0182    0.4727    1.0000         0         0
0         0         0    1.0000         0
0         0         0         0    1.0000``````

Second, we know that variance is the square of standard deviation. And we know the formula for covariance, which is variance divided by two standard deviations. So for the example here, we have:

``````% initialize
mt_varcov = zeros([5,5]);
% variance
mt_varcov(eye(5)==1) = ar_sd.^2;
% covariance
mt_varcov(1,2) = mt_cor(1,2)*ar_sd(1)*ar_sd(2);
mt_varcov(2,1) = mt_varcov(1,2);
mt_varcov(1,3) = mt_cor(1,3)*ar_sd(1)*ar_sd(3);
mt_varcov(3,1) = mt_varcov(1,3);
mt_varcov(2,3) = mt_cor(2,3)*ar_sd(2)*ar_sd(3);
mt_varcov(3,2) = mt_varcov(2,3);
% show
disp(mt_varcov(1:3,1:3));

0.1090    0.0135    0.0020
0.0135    0.1108    0.0521
0.0020    0.0521    0.1094

disp(mt_varcov(4:5,4:5));

5345344           0
0   179399236``````

## 1.2 Draw Five Correlated Shocks Using MVNRND

Generate N5 correlated shock structure

``````% Generate Scores
rng(123);
N = 50000;
mt_kw97_eps = mvnrnd(ar_mu, mt_varcov, N);
% graph
figure();
% subfigure 1
subplot(2,2,1);
scatter(mt_kw97_eps(:,1), mt_kw97_eps(:,2));
ylabel('White Collar Wage Shock');
xlabel('Blue Collar Wage Shock')
grid on;
% subfigure 2
subplot(2,2,2);
scatter(mt_kw97_eps(:,1), mt_kw97_eps(:,3));
ylabel('White Collar Wage Shock');
xlabel('Military Wage Shock')
grid on;
% subfigure 3
subplot(2,2,3);
scatter(mt_kw97_eps(:,3), mt_kw97_eps(:,2));
ylabel('Military Wage Shock');
xlabel('Blue Collar Wage Shock')
grid on;
% subfigure 4
subplot(2,2,4);
scatter(mt_kw97_eps(:,1), mt_kw97_eps(:,4));
ylabel('White Collar Wage Shock');
xlabel('School Shock')
grid on;``````