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Autocorrelation-Applied Tests

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106 views16 pages

Autocorrelation-Applied Tests

Uploaded by

Ansigar Chuwa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Applied Econometrics: A Modern Approach using Eviews and Microfit © Dr D Asteriou

Applied Econometrics

AUTOCORRELATION
1. What is Autocorrelation
2. What Causes Autocorrelation
3. First and Higher Orders
4. Consequences of Autocorrelation
5. Detecting Autocorrelation
6. Resolving Autocorrelation

1
Applied Econometrics

What is
What is Autocorrelation
Autocorrelation
Assumption 6 of the CLRM states that the
covariances and correlations between
different disturbances are all zero:
cov(ut, us)=0 for all t≠s
This assumption states that the disturbances ut
and us are independently distributed, which
is called serial independence.
Applied Econometrics

What is Autocorrelation
If this assumption is no longer valid, then the
disturbances are not pairwise independent, but
pairwise autocorrelated (or Serially Correlated).
This means that an error occurring at period t may be
carried over to the next period t+1.
Autocorrelation is most likely to occur in time series
data.
In cross-sectional we can change the arrangement of
the data without altering the results.
Applied Econometrics

What Causes Autocorrelation


One factor that can cause autocorrelation is omitted
variables.
Suppose Yt is related to X2t and X3t, but we wrongfully
do not include X3t in our model.
The effect of X3t will be captured by the disturbances
ut.
If X3t like many economic series exhibit a trend over
time, then X3t depends on X3t-1, X3t -2 and so on.
Similarly then u depends on u , u and so on.
Applied Econometrics

What Causes Autocorrelation


Another possible reason is misspecification.
Suppose Yt is related to X2t with a quadratic
relationship:
Yt=β1+β2X22t+ut
but we wrongfully assume and estimate a
straight line:
Yt=β1+β2X2t+ut
Then the error term obtained from the straight
line will depend on X22t.
Applied Econometrics

What Causes Autocorrelation


A third reason is systematic errors in measure-
ment.
Suppose a company updates its inventory at a given
period in time.
If a systematic error occurred then the cumulative
inventory stock will exhibit accumulated
measurement errors.
These errors will show up as an autocorrelated
procedure
Applied Econometrics

Consequences of Autocorrelation
1. The OLS estimators are still unbiased and consistent. This
is because both unbiasedness and consistency do not
depend on assumption 6 which is in this case violated.
2. The OLS estimators will be inefficient and therefore no
longer BLUE.
3. The estimated variances of the regression coefficients will
be biased and inconsistent, and therefore hypothesis testing
is no longer valid. In most of the cases, the R2 will be
overestimated and the t-statistics will tend to be higher.
Applied Econometrics

Detecting Autocorrelation
There are two ways in general.
The first is the informal way which is done through graphs
and therefore we call it the graphical method.
The second is through formal tests for autocorrelation, like
the following ones:

1. The Durbin Watson Test


2. The Breusch-Godfrey Test
3. The Durbin’s h Test (for the presence of lagged
dependent variables)
4. The Engle’s ARCH Test
Applied Econometrics

The Durbin Watson Test


The following assumptions should be satisfied:
1. The regression model includes a constant
2. Autocorrelation is assumed to be of first-
order only
3. The equation does not include a lagged
dependent variable as an explanatory variable
Applied Econometrics
The Durbin Watson Test
Step 1: Estimate the model by OLS and obtain
the residuals
Step 2: Calculate the DW statistic
Step 3: Construct the table with the calculated
DW statistic and the dU, dL, 4-dU and 4-dL
critical values.
Step 4: Conclude
Applied Econometrics

The Durbin Watson Test


Zone of No Zone of
indecision autocorrelation indecision
+ve autoc -ve autoc

0 dL dU 2 4-dU 4-dL 4
Applied Econometrics

The Durbin Watson Test


Drawbacks of the DW test
1. It may give inconclusive results
2. It is not applicable when a lagged dependent variable is
used
3. It can’t take into account higher order of
autocorrelation
Applied Econometrics
The Durbin’s
The Durbin’s hh Test
Test
When there are lagged dependent variables (i.e. Yt-1) then the DW
test is not applicable.
Durbin developed an alternative test statistic, named the h-
statistic, which is calculated by:
 DW  n
h  1  
 2  1  n ˆ
2

Where sigma of gamma hat square is the variance of the estimated


coefficient of the lagged dependent variable.
This statistic is distributed following the normal distribution
Applied Econometrics
The Durbin’s h Test
Dependent Variable: LOG(CONS)
Included observations: 37 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.  


C 0.834242 0.626564 1.331456 0.1922
LOG(INC) 0.227634 0.188911 1.204981 0.2368
LOG(CPI) -0.259918 0.110072 -2.361344 0.0243
LOG(CONS(-1)) 0.854041 0.089494 9.542982 0.0000

R-squared 0.940878     Mean dependent var 4.582683


Adjusted R-squared 0.935503     S.D. dependent var 0.110256
S.E. of regression 0.028001     Akaike info criterion -4.211360
Sum squared resid 0.025874     Schwarz criterion -4.037207
Log likelihood 81.91016     F-statistic 175.0558
Durbin-Watson stat 1.658128     Prob(F-statistic) 0.000000
Applied Econometrics

The Durbin’s h Test

 DW  n
h  1  
 2  1  n  2
ˆ

 1.658  37
 1    1.2971
 2  1  37 * 0.089 2
Applied Econometrics

Interpretation
The critical value for Durbin’s h Test at 5 % level of significance is
1.645

The null hypotheses is; no autocorrelation if the computed Durbin


h Test statistic is less than the critical value at 5 %.

Given the computed Durbin’s Test Statistic of 1.2971, we fail to


reject the null hypothesis of No autocorrelation, hence there is
no autocorrelation ( 1.2971 < 1.645 )

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