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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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
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