Autocorrelation,

Box Jenkins or ARIMA

Forecasting
 Autocorrelation and the Durbin-
Watson Test
Anautocorrelation
An autocorrelationisisaacorrelation
correlationofofthe
thevalues
valuesofofaavariable
variablewith
withvalues
valuesofofthe
thesame
samevariable
variablelagged
laggedone
oneoror

moreperiods
more periodsback.
back. Consequences
Consequencesofofautocorrelation
autocorrelationinclude
includeinaccurate
inaccurateestimates
estimatesofofvariances
variancesand
andinaccurate
inaccurate

predictions.
predictions.

Lagged Residuals
Lagged Residuals The Durbin-Watson test (first-order autocorrelation):
The Durbin-Watson test (first-order autocorrelation):
H0: 1 = 0
i
i
i
i i-1
i-1
i-2
i-2
i-3
i-3
i-4
i-4 H0: 1 = 0
1 1.0 * * * *
1 1.0 * * * * H1:0
H1:0
2 0.0 1.0 * * *
n
2 0.0 1.0 * * *
The Durbin-Watson test statistic:
3 -1.0 0.0 1.0 * * The Durbin-Watson test statistic:2
3 -1.0 0.0 1.0 * *
 ( ei  ei 1 )
d  i2 n
4 2.0 -1.0 0.0 1.0 *
4 2.0 -1.0 0.0 1.0 *
5 3.0 2.0 -1.0 0.0 1.0
5 3.0 2.0 -1.0 0.0 1.0
2
6
6 -2.0
-2.0
3.0
3.0
2.0
2.0
-1.0
-1.0
0.0
0.0  ei
7
7 1.0
1.0
-2.0
-2.0
3.0
3.0
2.0
2.0
-1.0
-1.0
i 1
8 1.5 1.0 -2.0 3.0 2.0
8 1.5 1.0 -2.0 3.0 2.0
9 1.0 1.5 1.0 -2.0 3.0
9 1.0 1.5 1.0 -2.0 3.0
10 -2.5 1.0 1.5 1.0 -2.0
10 -2.5 1.0 1.5 1.0 -2.0
 DW d Test

4 Steps

Step 1: Estimate
Yˆi  ˆ1  ˆ 2 X 2i  ˆ3 X 3i
And obtain the residuals

Step 2: Compute the DW d test statistic

Step 3: Obtain dL and dU: the lower and upper points

from the Durbin-Watson tables

 Step 4: Implement the following decision rule:
Value of d relative to dL and dU Decision

d < dL Reject null of no positive

autocorrelation
dL  d  dU No decision

dU < d < 4 - d U Do not reject null of no

positive or negative
autocorrelation

4 – dL < d < 4 - dU No decision

d > 4 - dL Reject null of no negative

autocorrelation
 Critical Points of the Durbin-Watson Statistic: =0.05,
n= Sample Size, k = Number of Independent
Variables
k=1 k=2 k=3 k=4 k=5
k=1 k=2 k=3 k=4 k=5
n dL dU dL dU dL dU dL dU dL dU
n dL dU dL dU dL dU dL dU dL dU
15 1.08 1.36 0.95 1.54 0.82 1.75 0.69 1.97 0.56 2.21
15 1.08 1.36 0.95 1.54 0.82 1.75 0.69 1.97 0.56 2.21
16 1.10 1.37 0.98 1.54 0.86 1.73 0.74 1.93 0.62 2.15
16 1.10 1.37 0.98 1.54 0.86 1.73 0.74 1.93 0.62 2.15
17 1.13 1.38 1.02 1.54 0.90 1.71 0.78 1.90 0.67 2.10
17 1.13 1.38 1.02 1.54 0.90 1.71 0.78 1.90 0.67 2.10
18 1.16 1.39 1.05 1.53 0.93 1.69 0.82 1.87 0.71 2.06
18 1.16 1.39 1.05 1.53 0.93 1.69 0.82 1.87 0.71 2.06
. . . . . .
. . . . . .
. . . . . .
. . . . . .
. . . . . .
. . . . . .
65 1.57 1.63 1.54 1.66 1.50 1.70 1.47 1.73 1.44 1.77
65 1.57 1.63 1.54 1.66 1.50 1.70 1.47 1.73 1.44 1.77
70 1.58 1.64 1.55 1.67 1.52 1.70 1.49 1.74 1.46 1.77
70 1.58 1.64 1.55 1.67 1.52 1.70 1.49 1.74 1.46 1.77
75 1.60 1.65 1.57 1.68 1.54 1.71 1.51 1.74 1.49 1.77
75 1.60 1.65 1.57 1.68 1.54 1.71 1.51 1.74 1.49 1.77
80 1.61 1.66 1.59 1.69 1.56 1.72 1.53 1.74 1.51 1.77
80 1.61 1.66 1.59 1.69 1.56 1.72 1.53 1.74 1.51 1.77
85 1.62 1.67 1.60 1.70 1.57 1.72 1.55 1.75 1.52 1.77
85 1.62 1.67 1.60 1.70 1.57 1.72 1.55 1.75 1.52 1.77
90 1.63 1.68 1.61 1.70 1.59 1.73 1.57 1.75 1.54 1.78
90 1.63 1.68 1.61 1.70 1.59 1.73 1.57 1.75 1.54 1.78
95 1.64 1.69 1.62 1.71 1.60 1.73 1.58 1.75 1.56 1.78
95 1.64 1.69 1.62 1.71 1.60 1.73 1.58 1.75 1.56 1.78
100 1.65 1.69 1.63 1.72 1.61 1.74 1.59 1.76 1.57 1.78
100 1.65 1.69 1.63 1.72 1.61 1.74 1.59 1.76 1.57 1.78
Durbin-Watson Test for Autocorrelation: An
Example
The Banner Rock Company Month Sales (000) Ad ($millions)

manufactures and markets its own 1 153 5.5

rocking chair. The company 2 156 5.5

developed special rocker for senior 3 153 5.3
citizens which it advertises 4 147 5.5
extensively on TV. Banner’s market 5 159 5.4
for the special chair is the Carolinas,
Florida and Arizona, areas where 6 160 5.3

there are many senior citizens and 7 147 5.5

retired people The president of 8 147 5.7

Banner Rocker is studying the 9 152 5.9
association between his advertising 10 160 6.2
expense (X) and the number of 11 169 6.3
rockers sold over the last 20 months
12 176 5.9
(Y). He collected the following data.
He would like to use the model to 13 176 6.1

forecast sales, based on the amount 14 179 6.2

spent on advertising, but is 15 184 6.2

concerned that because he gathered 16 181 6.5
these data over consecutive months 17 192 6.7
that there might be problems of 18 205 6.9
autocorrelation.
19 215 6.5

20 209 6.4
 Durbin-Watson Test for Autocorrelation: An Example
• Step 1: Generate the regression
equation
 Durbin-Watson Test for Autocorrelation: An Example

• The resulting equation is: Ŷ = - 43.802 + 35.95X

• The coefficient (r) is 0.828
• The coefficient of determination (r2) is 68.5%
• There is a strong, positive association between
sales and advertising
• Is there potential problem with autocorrelation?
Durbin-Watson Test for Autocorrelation: An Example

=-43.802+35.95*C3

=(E4-F4)^2

=E4^2

=B3-D3

=E3

∑(ei -ei-1)2 ∑(ei)2

Durbin-Watson Test for Autocorrelation:
An Example
• Hypothesis Test:
H0: No residual correlation (ρ = 0)
H1: Positive residual correlation (ρ > 0)

• Critical values for d given α=0.5, n=20, k=1

dl=1.20 du=1.41

Reject H0
Fail to reject H0
Positive Autocorrelation Inconclusive
No Autocorrelation

dl=1.20 du=1.41

 (e  e t t 1 )2
2338.5829
d t 2
n
  0.8522
2744.2685
 (e )
t 1
t
2
Autoregressive Models

11
Box Jenkins
or
Arima
Forecasting
• All stationary time series can be modeled as
AR or MA or ARMA models
• A stationary time series is one with constant

mean ( ) and constant variance.
• Stationary time series are often called mean
reverting series—that in the long run the
mean does not change (cycles will always
die out).
• If a time series is not stationary it is often
possible to make it stationary by using fairly
simple transformations
 Nonstationary Time series
• Linear trend
• Nonlinear trend
• Multiplicative seasonality
 How to make them stationary
• Linear trend
– Take non-seasonal difference. What is left over will be
stationary AR, MA or ARMA
• Nonlinear trend
• Exponential growth
– Take logs – this makes the trend linear
– Take non--seasonal difference
• Non exponential growth ?

Take logs
• Multiplicative seasonality often occurs when growth is
exponential.
 Identification
• What does it take to make the time series
stationary?
• Is the stationary model AR, MA, ARMA
– If AR(p) how big is p?
– If MA(q) how big is q?
– If ARMA(p,q) what are p and q?
 ARMA models
• If you can’t easily tell if the model is an AR
or a MA, assume it is an ARMA model.
 Box-Jenkins Method
First of all, the analyst identifies a tentative model
considering the nature of the past data. This tentative
model and the data are entered in the computer. The
Box-Jenkins program then gives the values of the
parameters included in the model. A diagnostic check
is then conducted to find out whether the model gives
an adequate description of the data. If the model
satisfies the analyst in this respect, then it is used to
make the forecast.