February 5, 2013
Serial correlation
Moursli Mohamed Reda
Recap
Autocorrelation Function
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Cov(zt , zts )
Var(zt )Var(zts )
Cov(zt , zts )
Var(zt )
Recap
Autocorrelation Function
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s =
0 s < T1
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The following four slides show the ACF and PACF of the monthly
US Stock Market Return Index, and that of US Dividend Yield
0.20
Autocorrelations of rusa
0.10
0.00
0.10
0.20
10
15
Lag
Bartletts formula for MA(q) 95% confidence bands
0.20
0.20
10
15
Lag
95% Confidence bands [se = 1/sqrt(n)]
1.00
Autocorrelations of pdusa
0.50
0.00
0.50
1.00
10
20
Lag
30
40
0.00
1.00
10
20
Lag
30
40
Corr[xt , xt+h ] 0 as h
In the case above, we call our series to be covariance
stationary or asymptotically uncorrelated
AR models
Introduction
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AR models
Properties
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0
=0
1 1
2
1 12
We need |1 | 6= 1 as otherwise
0 =
k 0
k
= 1 = 1k
0
0
2
2
=
=
0
1 12
2
<0
1 12
Estimation
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Tt=2 yt1 yt
Tt=2 yt1 (1 yt1 + ut )
=
Tt=2 y2t1
Tt=2 y2t1
= 1 +
Tt=2 yt1 ut
T
1
2
T t = 2 yt 1
1
T
At this point, we want to use the LLN to show that the last
term goes to zero. However, since {yt } is serially correlated
our usual LLN and CLT results cannot be used here.
Moursli Mohamed Reda
Assumptions:
1. E(ut |yt1 ) = 0.
2. {yt } is stationary.
3. yt and ytk become independent as k increases.
4. E(y4t ) is nonzero and finite.
Non-Stationarity
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R2 = 1
SSR
p 1
SST
where
T
SSR =
u 2t
t=1
u t = yt t
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The reason for why SSR/T is not exploding in the same way
as SST/T is that ut = yt t is stationary.
Moursli Mohamed Reda
The DF test
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SE()
The ADF test includes lags to the standard DF, based on the
persistance of the serial correlation in our error term
yt = (1 1)yt + i yti + ut
i=1
Serial Correlation
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The standard erros and test statistics are not valid (even
asymptotically)
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I
I
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yt = 0 + 1 xt1 + 2 xt2 + ut
Estimate our main model using OLS and extract se( 1 ), and
the OLS residuals u t
Run a regression of xt1 on the other explanatory variables
xt1 = 0 + 2 xt2 + rt