Applied Financial Beonometries Goh Kim Leng (a) Runs test Price changes can be positive, negative or zero depending on whether the price in the current period has increased, declined or remained unchanged from the previous period. A run is defined as a sequence of successive price changes of the same sign. There are 3 types of run: plus, minus ot zero. The actual number of runs R is then the sum of the number of runs for plus, minus and zero price changes. If Hp: price changes are random is true, then ECR) < (Mt - 2 mi [n , 3 mt [3 m4 nlrtt)) -2n 4, mn n? (a-1) where n is the number of observations (price changes) m) is the number of runs of each type (i=1 for positive price changes, i=2 for negative price changes and +3 for no price changes). Var (CR) = For la ge n, the test statistic Rto.5 -E(R) ie ql Var CR) follows approximately a standard normal distribution under Hy. rs NCO,1) The discontinuity adjustment is 40,5 if REE(R) and -0.5 if R>E(R). ‘The rejection region is Z<-Z,, fora a-level test. Advantage of the test is that it does not require any assumption about the underlying distribution (non-parametric). Weakness is that the test examines only one-period changes. (b) Autocorrelation Coefficients Serial dependence may be found over short periods of time (more than one period). The autocorrelation coefficient of lag k provides a measure of theApplied Financial Econometrics Gob Kim Leng strength of the linear relationship between the value of a variable at time t and its value k periods earlier. The autocorrelation coefficient of lag k is given by 2 ~ 2 Ty. -y) (ve-FVe-n -V) eck bs 2. aie z, (Ver? 4 where, ori = 7 ako If the n is small, we should use the adjusted autocorrelation coefficien fis. ait Va * Wk * Note that n, is computed in Eviews (not the adjusted r,), The null hypothesis ig Ho: py =0 where py is the population autocorrelation coefficient of lag k. If Hy is true, then the statistic , \ hv N¢ “y ae) 4. , —— The test statistic is given by ds Vp |W ke For Hy: p= 0, the rejection region is given by |Z [Sze (c) Liung-Box Q-Test Consider hypothesis testing at significance level . To test for serial correlations at different lags, several separate tests must be performed. The significance level of the combination of tests is quite different from a. To test for Ho! fr = Pa = ++ = Pls we use the following statistic: taApplied Financial Beonometries Gob Kim Leng (nea) ee SH) Uidite th, eC Silsh viconas The rejection region is: Qi > Zeke stic is computed in Eviews. (d) von Neumann’s Ratio Test This test can be used to test for serial correlation in the return series v;, Vay s+ Vae The test statistic is given by: Ly, Bley) *[On- 1) x ra (0) Tn Under Hy: no serial correlation in returns or p= 0, V follows a normal distribution with mean and variance: Zyx where Z= —— {var W) Note that the tests in (b), (c) and (d) are large-sample tests. In small samples, the assumption of normality is crucial.