Lecture10SerialCorrelation-NCKU.pdfVIP

Lecture 10 Serial Correlation In this lecture, you will learn the following: 1. What is the nature of autocorrelation? 2. What are the theoretical and practical consequences of autocorrelation? 3. Since the assumption of nonautocorrelation relates to the unobservable disturbance ε , how does one know that there is autocorrelation in any i given situation? 4. What are the remedies for the problem of autocorrelation? 10.1 Nature of Autocorrelation Below are some concepts about the independence and serial correlation (or autocorrelation) for a time series. • Serial independence: error terms ε and ε , for different observations t s t and s, are independently distributed. When one deals with time series data, this assumption is frequently violated. Error terms for time periods not too far apart may be correlated. • Serial correlation (or autocorrelation): error terms ε and ε , for t = s, t s are correlated. This property is frequently observed from time series data. 1 2 LECTURE 10 SERIAL CORRELATION • Besides, three factors can also lead to serially correlated errors. They are: (1) omitted variables, (2) ignoring nonlinearities, and (3) measure- ment errors. For example, suppose a dependent variable Yt is related to the independent variables Xt1 and Xt2 , but the investigator does not include Xt2 in the model. The effect of this variable will be captured by the error term ε . Because many time series exhibit trends over time, t Xt2 i