Type author name/s here

Dougherty

Introduction to Econometrics,
5th edition
Chapter heading
Chapter 12: Autocorrelation

© Christopher Dougherty, 2016. All rights reserved.

Durbin–Watson test

  uˆ t  uˆ t 1 
2

d t 2
T

 t
ˆ
u 2

t 1

The first major test to be developed and popularised for the detection of autocorrelation
was the Durbin–Watson test for AR(1) autocorrelation based on the Durbin–Watson d
statistic calculated from the residuals using the expression shown.
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 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

  uˆ t  uˆ t 1 
2

d t 2
T

 t
ˆ
u 2

t 1

In large samples d → 2 – 2r

It can be shown that in large samples d tends to 2 – 2r, where r is the parameter in the
AR(1) relationship ut = rut–1 + et.

2
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

  uˆ t  uˆ t 1 
2

d t 2
T

 t
ˆ
u 2

t 1

In large samples d → 2 – 2r
No autocorrelation d→2

If there is no autocorrelation, r is 0 and d should be distributed randomly around 2.

3
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

  uˆ t  uˆ t 1 
2

d t 2
T

 t
ˆ
u 2

t 1

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0

If there is severe positive autocorrelation, r will be near 1 and d will be near 0.

4
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

  uˆ t  uˆ t 1 
2

d t 2
T

 t
ˆ
u 2

t 1

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

Likewise, if there is severe positive autocorrelation, r will be near –1 and d will be near 4.

5
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 2 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

Thus d behaves as illustrated graphically above.

6
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dcrit 2 dcrit 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

To perform the Durbin–Watson test, we define critical values of d. The null hypothesis is
H0: r = 0 (no autocorrelation). If d lies between these values, we do not reject the null
hypothesis.
7
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dcrit 2 dcrit 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

The critical values, at any significance level, depend on the number of observations in the
sample and the number of explanatory variables.

8
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dcrit dU 2 dcrit 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

Unfortunately, they also depend on the actual data for the explanatory variables in the
sample, and thus vary from sample to sample.

9
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dcrit dU 2 dcrit 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

However Durbin and Watson determined upper and lower bounds, dU and dL, for the critical
values, and these are presented in standard tables.

10
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dcrit dU 2 dcrit 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

If d is less than dL, it must also be less than the critical value of d for positive
autocorrelation, and so we would reject the null hypothesis and conclude that there is
positive autocorrelation.
11
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dcrit dU 2 dcrit 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

If d is above than dU, it must also be above the critical value of d, and so we would not
reject the null hypothesis. (Of course, if it were above 2, we should consider testing for
negative autocorrelation instead.)
12
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dcrit dU 2 dcrit 4

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

If d lies between dL and dU, we cannot tell whether it is above or below the critical value and
so the test is indeterminate.

13
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.43 1.62
(n = 45, k = 3, 5% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

Here are dL and dU for 45 observations and two explanatory variables, at the 5% significance
level.

14
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.43 1.62 2.38 2.57
(n = 45, k = 3, 5% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

There are similar bounds for the critical value in the case of negative autocorrelation. They
are not given in the standard tables because negative autocorrelation is uncommon, but it
is easy to calculate them because are they are located symmetrically to the right of 2.
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 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.43 1.62 2.38 2.57
(n = 45, k = 3, 5% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

So if d < 1.43, we reject the null hypothesis and conclude that there is positive
autocorrelation.

16
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.43 1.62 2.38 2.57
(n = 45, k = 3, 5% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

If 1.43 < d < 1.62, the test is indeterminate and we do not come to any conclusion.

17
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.43 1.62 2.38 2.57
(n = 45, k = 3, 5% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

If 1.62 < d < 2.38, we do not reject the null hypothesis of no autocorrelation.

18
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.43 1.62 2.38 2.57
(n = 45, k = 3, 5% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

If 2.38 < d < 2.57, we do not come to any conclusion.

19
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.43 1.62 2.38 2.57
(n = 45, k = 3, 5% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

If d > 2.57, we conclude that there is significant negative autocorrelation.

20
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.24 1.42 2.58 2.76
(n = 45, k = 3, 1% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

Here are the bounds for the critical values for the 1% test, again with 45 observations and
two explanatory variables.

21
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.24 1.42 2.58 2.76
(n = 45, k = 3, 1% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

The Durbin-Watson test is valid only when all the explanatory variables are deterministic.
This is in practice a serious limitation since usually interactions and dynamics in a system
of equations cause Assumption C.7 part (2) to be violated.
22
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.24 1.42 2.58 2.76
(n = 45, k = 3, 1% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

In particular, if the lagged dependent variable is used as a regressor, the statistic is biased
towards 2 and therefore will tend to under-reject the null hypothesis. It is also restricted to
testing for AR(1) autocorrelation.
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 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.24 1.42 2.58 2.76
(n = 45, k = 3, 1% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

Despite these shortcomings, it remains a popular test and some major applications
produce the d statistic automatically as part of the standard regression output.

24
 TESTS FOR AUTOCORRELATION II: DURBIN–WATSON TEST

Durbin–Watson test

positive no negative
autocorrelation autocorrelation autocorrelation

0 dL dU 2 4
1.24 1.42 2.58 2.76
(n = 45, k = 3, 1% level)

In large samples d → 2 – 2r
No autocorrelation d→2
Severe positive autocorrelation d→0
Severe negative autocorrelation d→4

It does have the appeal of the test statistic being part of standard regression output.
Further, it is appropriate for finite samples, subject to the zone of indeterminacy and the
deterministic regressor requirement.
25
Copyright Christopher Dougherty 2016.

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The content of this slideshow comes from Section 12.2 of C. Dougherty,

Individuals studying econometrics on their own who feel that they might benefit
from participation in a formal course should consider the London School of
Economics summer school course
EC212 Introduction to Econometrics
http://www2.lse.ac.uk/study/summerSchools/summerSchool/Home.aspx
or the University of London International Programmes distance learning course
20 Elements of Econometrics
www.londoninternational.ac.uk/lse.

2016.05.22