Introduction to Econometrics

1. Introduction to Econometrics Lecture 8 Autocorrelation

2. Econometric problems

3. 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

4. Autocorrelated series and autocorrelated disturbances

5. 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

6. First-order autocorrelation

7. The sources of autocorrelation

8. The consequences of autocorrelation

9. Detecting autocorrelation

10. The Durbin-Watson test

11. More on the Durbin-Watson statistic

12. Using the Durbin-Watson statistic

13. Durbin-Watson critical values

14. The Breusch-Godfrey (LM) test

15. The Breusch-Godfrey test continued

16. 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