Autocorrelation

Autocorrelation

Assumption of OLS regression is that error

terms are independent and normally distributed,
with a mean zero and a constant variance

If this assumption violate serial correlation is

indicated

Autocorrelation
(continued)

Autocorrelation is correlation of the error terms

(residuals) over time

Here, residuals show

a cyclic pattern, not
random

Violates the regression assumption that

residuals are random and independent

More common in time series data

if we are dealing with time series data, for the

observations in such data follow a natural ordering
over time so that successive observations are likely
to exhibit intercorrela- tions, especially if the time
interval between successive observations is short,
such as a day, a week, or a month rather than a year.
If you observe stock price indexes, such as the Dow
Jones or S&P 500 over successive days, it is not
unusual to nd that these indexes move up or down
for several days in succession. Obviously, in situations
like this, the assumption of no auto, or serial,
correlation in the error terms will be violated.

Autocorrelation can arise for several reasons

inertia or sluggishness of economic time series

specication bias resulting from excluding
important variables from the model
using incorrect functional form
data transformation.

No pattern in residuals
No autocorrelation
u t

u t

Time

u t 1

No pattern in residuals at all: this is what we would like to see

Positive Autocorrelation
+
u t

u t

u t 1

Time

Positive Autocorrelation is indicated by a cyclical residual plot over time.

Negative Autocorrelation
u t

+
u t

Time

u t 1

Negative autocorrelation is indicated by an alternating pattern where the residuals

cross the time axis more frequently than if they were distributed randomly

problems

Makes the estimates of the standard errors

smaller than the true standard error. This
means that t ratio calculated will be overstated
R square and F statistic unreliable

cause

Existence of long term cycles and trends in

business and economic data.this leads to
positive serial correlation
Also caused by mis specification.leaving
one or more important variable or not including
a non linear term when needed

How to remove

Use first differences rather than actual values

Specify the model by adding variables
Introduce the square of an existing causal
variable as an independent variable
Introduce a lag on dependent variable as an
independent variable
Introduce a lag of the dependent variable as an
independent variable

Testing for Autocorrelation

The Durbin-Watson Statistic is used to test for

autocorrelation
H0: = 0
HA: > 0

(residuals are not correlated)

(positive autocorrelation is present)
(The test for positive autocorrelation is the most
common test in business applications)

Durbin-Watson test statistic:

n

2
(
e

e
)
t t 1
t 1

et
t 1

d = Durbin-Watson test statistic

ei = (y t y t ) = residual at time t

n = number of time periods in the time series

Measuring autocorrelation in SPSS

Autocorrelation is measured by Durbin Watson

Statistic
The value of Durbin Watson statistic ranges
from 0 to 4
If it is between 2 and 4-negative autocorrelation
If it is between 0 and 2-positive autocorrelation

SPSS