Chapter 10
Ch.10 Time Series Data - Basic
Time Series Data
yt = 0 + 1xt1 + . . .+ kxtk + ut
1. Basic Analysis
Econometrics
10.1 Nature of Time Series Data
Time series data has a temporal ordering,
unlike cross-section data (see table10.1).
 Past can affect the future, but not vice versa.
 So, we will need to alter some of our assumptions
to take into account that we no longer have an
usual random sample of individuals.
Instead, we have one realization of a
stochastic process. (i.e. random)
Econometrics
Finite Distributed Lag Models
yt = 0+0zt+1zt-1+…+qzt-q+ut (10.6)
We can call 0 the impact propensity – it
reflects the immediate change in y.
 For a temporary, 1-period change, y returns to
its original level in period q+1. (see fig.10.1)
We can call 0 + 1 +…+ q the long-run
propensity (LRP) – it reflects the long-run
change in y after a permanent change.
Econometrics
Time Series Data: Basic
1. The Nature of Time Series Data
2. Examples of Times Series Regression
3. Finite Sample Properties of OLSE
4. Functional Form, Dummy Variables
& Index Numbers*
5. Trends & Seasonality
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10.2 Examples of Time Series Models
A static model relates contemporaneous
variables:
yt = 0 + 1zt + ut (10.1)
A finite distributed lag (FDL) model allows
one or more variables to affect y with a lag:
yt = 0+0zt+1zt-1+2zt-2+ut (10.5)
 More generally, a finite distributed lag model of
order q will include q lags of z.
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10.3 Finite Sample Properties of OLSE
Assumptions for Unbiasedness
1. Linear in parameters:
yt = 0 + 1xt1 + . . .+ kxtk + ut (10.8)
2. No perfect collinearity:
No x is constant or a perfect linear
combination of the others.
3. Zero conditional mean:
E(ut|X) = 0, t = 1, 2, …, n (10.9)
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Chapter 10
Zero Conditional Mean Assumption
Note that this implies the error term in any
given period is uncorrelated with the
explanatory variables in all time periods.
 The x’s are strictly exogenous.
 Note we have skipped the random sample
assumption, that each ui is independent. Our
strict exogeneity assumption takes care of it in
the case.
Econometrics
Unbiasedness of OLS
Based on these 3 assumptions, when using
time-series data, the OLS estimators are
unbiased.
 Thus, just as the case with cross-section data,
under the appropriate conditions OLS is
unbiased.
Omitted variable bias can be analyzed in
the same manner as in the cross-section case.
Econometrics
Gauss-Markov Assumptions
Under these 5 assumptions, OLS variances
& the estimators of 2 in time series case
are the same as in the cross section case.
 See theorem 10.2 & 10.3
Under the time series Gauss-Markov
assumptions, the OLS estimators are BLUE.
 Even in cross sectional data, non-random
sampling case needs these assumptions.
Econometrics 11
Time Series Data: Basic
Cont. Zero Conditional Mean
An alternative assumption, more parallel
to the cross-sectional case, is E(ut|xt) = 0.
 This assumption would imply the x’s are
contemporaneously exogenous.
 In this case, ut and xt are contemporaneously
independent.
 Contemporaneous exogeneity will only be
sufficient in large samples.
7 Econometrics 8
Variances of OLS Estimators
Assumptions for Efficiency
4. Homosckedasticity:
Var(ut|X) = Var(ut) = 2
 The error variance is independent of all the
x’s, and it is constant over time.
5. No serial correlation:
Corr(ut,us|X) = 0 for t  s (10.12)’
 When (10.12)’ is false, the error terms suffer
from serial correlation, or autocorrelation.
9 Econometrics 10
Inference under the CLM Assumptions
Assumptions for Hypothesis testing
6. Normality:
 The errors are independently and identically
distributed as Normal.
With this assumption, inference in time
series case is also the same as in cross
section.
 See theorem 10.5
Econometrics 12
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Chapter 10

10.5 Trends & Seasonality Controlling the Trends

Trending Time Series Linear trend:
Economic time series often have a trend. yt = 0 + 1t + et, t = 1, 2, … (10.24)
If y & x series are trending together, we
Exponential trend:
can’t assume that the relation is causal.
 Often, both will be trending because of other ln(yt) = 0 + 1t + et, t = 1, 2, … (10.26)
unobserved factors. Quadratic trend:
Even if those factors are unobserved, we yt = 0 + 1t + 2t2 + et, t = 1, 2, … (10.29)
can control for them by directly controlling
for the trend.
Econometrics 13 Econometrics 14

Using Trending Variables Detrending Interpretation

Though nothing about trending variables
Adding a linear trend term to a regression
necessarily violates the CLM assumptions,
is the same thing as using “detrended”
trending factors that affect y might also be
series in a regression.
correlated with x.
 Detrending a series involves regressing each
 If we ignore this possibility, we may find variable in the model on t.
spurious relationship between y and x.
 The residuals form the detrended series.
Adding a time trend eliminates this problem:
Basically, the trend has been partialled out
yt = 0 + 1xt1 + 2xt2+ 3t + ut (10.31)
by adding the term.
Econometrics 15 Econometrics 16

Computing R2 & Detrending Seasonality

Often time-series data exhibits some
Time-series regressions tend to have very
periodicity, referred to seasonality.
high R2, as the trend is well explained.
 Example: Quarterly data on retail sales will
An advantage to actually detrending the tend to jump up in the 4th quarter.
data (vs. adding a trend) involves the
Seasonality can be dealt with by adding a
calculation of goodness of fit.
set of seasonal dummies.
The R2 from a regression on detrended data  As with trends, the series can be seasonally
better reflects how well the xt’s explain yt. adjusted before running the regression.

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Time Series Data: Basic 3