3.2.

3 Stationarity Definition

A great deal of importance is given to the stationarity assumption in this

research as is a very important split point in the methodology roadmap in estimation

dealing with time series data. A stationary process is defined as series that always

come back to the mean, have an equal variance and the covariance between any two

values in the series depends solely in the interval of time that separates them (e.g.,

white noise process). Time series data with changing means and variances are

referred as non-stationary (Hamilton, 1994). One of the processes that is often

associated with such data is a random walk, meaning that the series behaves in an

unpredictable pattern similar to that of a winding road. In model estimation,

especially when using econometric estimators that depend on the stationary

assumption, non-stationary series result in estimation, inference and forecasting

problems. Granger and Newbold (1974) demonstrated that when fitting a regression

with two random walk variables, spurious results are possible. In order to attain

consistent and reliable results, the consensus in the literature (e.g., Hamilton (1994),

and Enders (2004)) is to first determine the type of time series process and then use

filtering techniques accordingly. That is to transform deterministic trends using

detrending (demeaning), and stochastic trends employing differencing or ARIMA

filters. Simply stated, the goal is to convert the unpredictable process to one that has a

mean coming back to a long term average and a variance that does not depend on

time.

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