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Explanation: Dickey-Fuller Table

Explanation[edit] A simple AR(1) model is y_{t}=\rho y_{t-1}+u_{t}\, where y_{t} is the variable of interest, t is the time index, \rho is a coefficient, and u_{t} is the error term. A unit root is present if \rho = 1. The model would be non-stationary in this case. The regression model can be written as \nabla y_{t}=(\rho-1)y_{t-1}+u_{t}=\delta y_{t-1}+ u_{t}\, where \nabla is the first difference operator. This model can be estimated and testing for a unit root is equivalent to testing \delta = 0 (where \delta \equiv \rho - 1). Since the test is done over the residual term rather than raw data, it is not possible to use standard t-distribution to provide critical values. Therefore this statistic t has a specific distribution simply known as the Dickey–Fuller table. There are three main versions of the test: 1. Test for a unit root: \nabla y_t =\delta y_{t-1}+u_t \, 2. Test for a unit root with drift: \nabla y_t =a_0+\delta y_{t-1}+u_t \, 3. Test for a unit root with drift and deterministic time trend: \nabla y_t = a_0+a_1t+\delta y_{t-1}+u_t \, Each version of the test has its own critical value which depends on the size of the sample. In each case, the null hypothesis is that there is a unit root, \delta = 0. The tests have low statistical power in that they often cannot distinguish between true unit-root processes (\delta = 0)and near unit-root processes (\delta is close to zero). This is called the "near observation equivalence" problem. The intuition behind the test is as follows. If the series y is stationary (or trend stationary), then it has a tendency to return to a constant (or deterministically trending) mean. Therefore large values will tend to be followed by smaller values (negative changes), and small values by larger values (positive changes). Accordingly, the level of the series will be a significant predictor of next period's change, and will have a negative coefficient. If, on the other hand, the series is integrated, then positive changes and negative changes will occur with probabilities that do not depend on the current level of the series; in a random walk, where you are now does not affect which way you will go next. It is notable that

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99 views2 pages

Explanation: Dickey-Fuller Table

Explanation[edit] A simple AR(1) model is y_{t}=\rho y_{t-1}+u_{t}\, where y_{t} is the variable of interest, t is the time index, \rho is a coefficient, and u_{t} is the error term. A unit root is present if \rho = 1. The model would be non-stationary in this case. The regression model can be written as \nabla y_{t}=(\rho-1)y_{t-1}+u_{t}=\delta y_{t-1}+ u_{t}\, where \nabla is the first difference operator. This model can be estimated and testing for a unit root is equivalent to testing \delta = 0 (where \delta \equiv \rho - 1). Since the test is done over the residual term rather than raw data, it is not possible to use standard t-distribution to provide critical values. Therefore this statistic t has a specific distribution simply known as the Dickey–Fuller table. There are three main versions of the test: 1. Test for a unit root: \nabla y_t =\delta y_{t-1}+u_t \, 2. Test for a unit root with drift: \nabla y_t =a_0+\delta y_{t-1}+u_t \, 3. Test for a unit root with drift and deterministic time trend: \nabla y_t = a_0+a_1t+\delta y_{t-1}+u_t \, Each version of the test has its own critical value which depends on the size of the sample. In each case, the null hypothesis is that there is a unit root, \delta = 0. The tests have low statistical power in that they often cannot distinguish between true unit-root processes (\delta = 0)and near unit-root processes (\delta is close to zero). This is called the "near observation equivalence" problem. The intuition behind the test is as follows. If the series y is stationary (or trend stationary), then it has a tendency to return to a constant (or deterministically trending) mean. Therefore large values will tend to be followed by smaller values (negative changes), and small values by larger values (positive changes). Accordingly, the level of the series will be a significant predictor of next period's change, and will have a negative coefficient. If, on the other hand, the series is integrated, then positive changes and negative changes will occur with probabilities that do not depend on the current level of the series; in a random walk, where you are now does not affect which way you will go next. It is notable that

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Explanation[edit]

A simple AR(1) model is

where

is the variable of interest,

is the time index,

the error term. A unit root is present if

is a coefficient, and

is

. The model would be non-stationary in

this case.
The regression model can be written as

where

is the first difference operator. This model can be estimated and testing

for a unit root is equivalent to testing

(where

). Since the test is

done over the residual term rather than raw data, it is not possible to use
standard t-distribution to provide critical values. Therefore this statistic

has a

specific distribution simply known as the DickeyFuller table.


There are three main versions of the test:
1. Test for a unit root:

2. Test for a unit root with drift:

3. Test for a unit root with drift and deterministic time trend:

Each version of the test has its own critical value which depends on
the size of the sample. In each case, the null hypothesis is that there is
a unit root,

. The tests have lowstatistical power in that they

often cannot distinguish between true unit-root processes (

)and

near unit-root processes ( is close to zero). This is called the "near


observation equivalence" problem.
The intuition behind the test is as follows. If the series
is stationary (or trend stationary), then it has a tendency to return to a
constant (or deterministically trending) mean. Therefore large values
will tend to be followed by smaller values (negative changes), and
small values by larger values (positive changes). Accordingly, the level
of the series will be a significant predictor of next period's change, and
will have a negative coefficient. If, on the other hand, the series is
integrated, then positive changes and negative changes will occur with
probabilities that do not depend on the current level of the series; in

Pg.1/2

a random walk, where you are now does not affect which way you will
go next.
It is notable that

Pg.2/2

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