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Introduction to Econometrics. Lecture 8 Autocorrelation. Econometric problems. Topics to be covered. Overview of autocorrelation First-order autocorrelation and the Durbin-Watson test Higher-order autocorrelation and the Breusch-Godfrey test Dealing with autocorrelation

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introduction to econometrics

Introduction to Econometrics

Lecture 8

Autocorrelation

slide3

Topics to be covered

  • Overview of autocorrelation
  • First-order autocorrelation and the Durbin-Watson test
  • Higher-order autocorrelation and the Breusch-Godfrey test
  • Dealing with autocorrelation
  • Examples and practical illustrations
slide5

Overview of autocorrelation

What is meant by autocorrelation The error terms are not independent from observation to observation – ut depends on one or more past values of u

What are its consequences? The least squares estimators are

no longer “efficient” (i.e. they don’t have the lowest variance).

More seriously autocorrelation may be a symptom of model

misspecification

How can you detect the problem? Plot the residuals against

time or their own lagged values, calculate the Durbin-Watson

statistic or use some other tests of autocorrelation such as the Breusch-Godfrey test

How can you remedy the problem? Consider possible model

re-specification of the model: a different functional form,

missing variables, lags etc. If all else fails you could correct for autocorrelation by using the Cochrane-Orcutt procedure or Autoregressive Least Squares

slide16

Dealing with autocorrelation

  • How should you deal with a problem of autocorrelation?
  • Consider possible re-specification of the model:
  • a different functional form,
  • the inclusion of additional explanatory variables,
  • the inclusion of lagged variables (independent and dependent)
  • If all else fails you can correct for autocorrelation by using the Cochrane-Orcutt procedure or Autoregressive Least Squares
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