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Autocorrelation
utoco e at o may
ay be defined
de ed as correlation
co e at o between
betwee Thiss iss in many
a y ways ssimilar
a to tthee problem
p ob e of
o
members of series of observations ordered in time or space. heteroscedasticity.
CLRM assumes that E(uiuj ) = 0 Under both heteroscedasticity and autocorrelation the usual
Consider the regression of output on labor and capital inputs, in a quarterly
time series data. If there is a labor strike affecting output in one quarter, there
OLS estimators, although linear, unbiased, and asymptotically
is no reason to believe that this disruption will be carried over to the next normally distributed, have no longer the minimum variance
quarter. (not efficient) among all linear unbiased estimators.
If output is lower this quarter
quarter, there is no reason to expect it to be lower next
Thus, they may not be BLUE.
quarter.
As a result, the usual, t, F, and 2 may not be valid.
In cross-section studies:
Data are often collected on the basis of a random sample of say households.
There is often no prior reason to believe that the error term pertaining to one
household is correlated with the error term of another household.
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1. Inertia
a. Figure a shows a cyclical A prominent feature of most economic time series.
pattern. There is a momentum built into them, and it continues until something
b. Figure b suggests an upward happens.
linear trend.
2. Specification Bias: Excluded Variables Case
c. Figure c shows a downward
The price of chicken may affect the consumption of beef. Thus, the error
linear trend in the
disturbances, term will reflect a systematic pattern, if this is excluded.
d. Figure d indicates that both 3. Specification Bias: Incorrect Functional Form
linear and quadratic trend If X2i is incorrectly omitted from the model, a systematic fluctuation in the
terms are present in the error term and thus autocorrelation will be detected because of the use of an
disturbances. incorrect functional form.
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U
Under
de the
t e AR(1)
( ) scheme,
sc e e, itt can
ca be shown
s ow that
t at For
o a two-variable
two va ab e model
ode and
a d a AR(1)
( ) scheme,
sc e e, we can
ca show
s ow that
t at
following are BLUE:
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G
Graphical
ap ca Method:
et od:
Very often a visual examination of the estimated us gives us some clues about
the likely presence of autocorrelation in the us.
We can simply plot them against time in a time sequence plot.
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Let
et The
e most
ost ce
celebrated
eb ated test for
o detect
detecting
g se
serial
a co
correlation:
e at o :
N = total number of observations = N1 + N2
N1 = number of + symbols
N2 = number of symbols
R = number of runs Assumptions underlying the d statistic:
H0: successive outcomes are independent 1. The regression model includes the intercept term. If it is not present, obtain
the RSS from the regression including the intercept term.
If N1 and N2 > 10,
10 R ~ N( , ) 2. The
Th explanatory
l variables
i bl are nonstochastic,
h i or fixed
fi d in
i repeatedd sampling.
li
Decision Rule: 3. The disturbances are generated by the first-order autoregressive scheme.
Reject H0 if the estimated R lies outside the limits. 4. The error term is assumed to be normally distributed.
Prob [E(R) 1.96R R E(R) + 1.96R] = 0.95 5. The regression model does not include the lagged value of the dependent
variable as one of the explanatory variables. (no autoregressive model)
6. There are no missing observations in the data.
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If autoco
autocorrelation
e at o iss found,
ou d, we have
ave four
ou options:
opt o s: For
o tthee wagesproductivity
wages p oduct v ty regression:
eg ess o :
It may be safe to conclude that
1. Try to find out if the autocorrelation is pure autocorrelation and not the result probably the model suffers from pure
of mis-specification of the model. autocorrelation and not necessarily
2. In case of pure autocorrelation, one can use some type of generalized least- from specification bias.
square (GLS) method.
3. In large samples, we can use the NeweyWest method to obtain standard
errors of OLS estimators that are corrected for autocorrelation
autocorrelation.
4. In some situations we can continue to use the OLS method.
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The
e First-Difference
st e e ce Method:
et od: Based
ased oon DurbinWatson
u b Watso d Stat
Statistic:
st c:
Since lies between 0 and 1, one could start from two extreme positions. If we cannot use the first difference transformation because is not sufficiently
= 0: No (first-order) serial correlation, close to 1:
= 1: perfect positive or negative correlation. In reasonably large samples one can obtain rho from and use GLS.
If = 1: Yt Yt-1 = 2(Xt Xt-1) + (ut ut-1)
This may be appropriate if the coefficient of autocorrelation is very high. Estimated from the Residuals:
A rough rule of thumb: Use the first difference form whenever d < R2 If AR(1) scheme is valid, run the following regression:
Use the g statistic to test the hypothesis that = 1. No need to introduce the intercept, as we know the OLS residuals sum to zero.
ut are the OLS residuals from the original regression
et are the OLS residuals from the first-difference regression.
An estimate of is obtained and then used to estimate the GLS.
Use DurbinWatson tables except that now the null hypothesis is that = 1.
g = 0.0012, dL = 1.435 and dU = 1.540: As the observed g lies below the
Thus, all these methods of estimation are known as feasible GLS
lower limit of d, we do not reject the hypothesis that true = 1 (FGLS) or estimated GLS (EGLS) methods.
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Instead of FGLS methods, OLS with corrected SEs can be used Recall the US savings
savingsincome
income regression model for 1970
19701995:
1995:
in large samples. Yt = 1 + 2Dt + 1Xt + 2(DtXt) + ut
Y = savings; X = income; D = 1 for 19821995; D = 0 for 19701981
This is an extension of Whites correction. Suppose that ut follows a AR(1) scheme:
The corrected SEs are known as HAC (heteroscedasticity- and Use the generalized difference method to estimate the parameters.
autocorrelation-consistent) standard errors. How do we transform the dummy?
We will not present the mathematics behind, for it is involved. One can follow the following procedure:
1. D = 0 ffor 1970
19701981;
1981 D = 1/(1 )) for
f 1982
1982; D = 1 ffor 1983
19831995.
1995
The wagesproductivity regression with HAC standard errors: 2. Transform Xt as (Xt Xt-1).
3. DtXt is zero for 19701981; DtXt = Xt for 1982; and the remaining
observations are set to (DtXt DtXt-1) = (Xt Xt-1).
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Homework 6
Basic
as c Econometrics
co o et cs (Gujarati,
(Guja at , 2003)
003)