Econometrics SORS 4104

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Contents

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Violation GLM Assumptions
• Autocorrelation

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Autocorrelation
• Autocorrelation can be either positive or negative. Positive
autocorrelation means that the current value of a variable is more
likely to be similar to its past values, while negative autocorrelation
means that the current value of a variable is more likely to be different
from its past values.
• Autocorrelation can be a problem in econometrics because it can
violate the assumptions of many econometric models. For example,
the assumption of independence of the error terms is violated when
there is autocorrelation in the data.

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Causes
• Omitted variable bias:
• If an important variable is omitted from the model, the error terms may be autocorrelated. This is
because the omitted variable may capture some of the dynamic behavior of the dependent
variable.
• Lagged dependent variables:
• If the model includes lagged dependent variables, the error terms may be autocorrelated. This is
because the lagged dependent variables are correlated with the current value of the dependent
variable.
• Measurement errors:
• If there are measurement errors in the data, the error terms may be autocorrelated. This is
because the measurement errors may introduce a trend or cycle into the data.
• Economic dynamics:
• The dynamic behavior of the economy itself can also cause autocorrelation. For example, if there
is a recession, the unemployment rate is likely to be high for a number of years. This is because
it takes time for the economy to recover from a recession.
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Data treatment: e.g sampling method implemented
 Other possible causes of autocorrelation include:

• Aggregation bias: If the data is aggregated over time, this can introduce autocorrelation into
the data. This is because the aggregate data may capture some of the dynamic behavior of the
individual units.
• Seasonality: If the data is seasonal, this can also introduce autocorrelation into the data. This is
because the data may follow a regular pattern over time, such as a monthly or quarterly pattern.
• Spatial autocorrelation: If the data is spatial, this can also introduce autocorrelation into the
data. This is because the data may be correlated with the data for nearby units.

• Here are some examples of autocorrelation in econometrics:

• The unemployment rate may be autocorrelated, meaning that the current unemployment rate is
more likely to be similar to its past values. This is because it takes time for the economy to
adjust to changes in the unemployment rate.
• The stock market may be autocorrelated, meaning that the current stock market index is more
likely to be similar to its past values. This is because investors may tend to follow trends in the
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stock market.
Consequences of autocorrelation
• Biased estimates: Autocorrelation can lead to biased estimates of the
model parameters. This is because the error terms in the model are not
independent, as is assumed by many econometric models.
• Inefficient estimates: Autocorrelation can also lead to inefficient
estimates of the model parameters. This is because the variance of the
estimates is greater than it would be if the error terms were
independent.
• Invalid hypothesis tests: Autocorrelation can also make hypothesis
tests invalid. This is because the standard errors of the estimates are
biased, which leads to incorrect p-values.

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The following proposition explain consequences
of autocorrelation mathematically

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 The Durbin-Watson test
• The Durbin-Watson test is a statistical test used to detect the presence of autocorrelation in the
residuals of a regression model.
• How the Durbin-Watson test works:
1.Formulate the Regression Model: First, you need to specify and estimate your regression model.
This typically involves running a linear regression analysis.
2.Obtain Residuals: Calculate the residuals by subtracting the predicted values of the dependent
variable from the actual observed values. These residuals represent the unexplained variation in the
dependent variable.
3.Calculate the Durbin-Watson Statistic: The Durbin-Watson statistic (DW) is calculated using the
formula:
DW = Σ(μt - μ (t-1))^2 / Σut^2
where:
1. μ t is the residual at time t.
2. μ (t-1 ) is the residual at the previous time t-1.
The DW statistic measures the extent to which adjacent residuals are correlated. If there is no
autocorrelation, the DW statistic will be closebytoMiss2.E Nyakujipa
• Interpret the DW Statistic:
• d< 2: Indicates positive autocorrelation (residuals are positively correlated).
• d > 2: Indicates negative autocorrelation (residuals are negatively correlated).
• d ≈ 2: Suggests no significant autocorrelation (residuals are approximately
independent).
• Draw Conclusions:
• Based on the DW statistic and critical values, draw conclusions about the presence and
direction of autocorrelation in your regression model's residuals.
• Address Autocorrelation:
• If autocorrelation is detected, you may need to take corrective measures. Common
approaches include using autoregressive models, differencing the data, or adding
lagged independent variables to the model.
• Limitations
May not be suitable for all types of data or models.
Other diagnostic tests and visual inspections of residual plots are often used in
conjunction with the Durbin-Watson test toby Miss
assess autocorrelation thoroughly.
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Worked example

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estimation

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