Autocorrelation Problem - Econometric Modeling - Lecture Notes, Study notes for Econometrics. Agra University

Econometrics

Description: Econometric models are statistical models used in econometric. This modelling tool help economist develop future economy plan for the company. This lecture note discuss important points for understanding Econometric modelling, it includes Autocorrelation, Consequences, Problem, Detection, Criteria, Causes, Measures
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13. MODULE OBJECTIVE
This module attempts to explore the possibilities of correlation in cross sectional units of error
variables.
The estimated model by the application of OLS, discussed earlier, is based on the assumption
that there should not be any relationship among the error regressors. That is covariance between
two errors variables should equal to zero [i.e. Cov (Ui, Uj) = 0 for i j]. If this assumption is
violated, then there is chance of autocorrelation. It is otherwise called as serial correlation. So,
serial correlation occurs when the error in estimated econometric models are correlated.
In this module, we deal with the followings:
1. WHAT IS AUTOCORRELATION AND HOW IS ITS NATURE?
2. WHAT ARE ITS CONSEQUENCES?
3. DOES IT REALLY A PROBLEM?
4. DETECTION CRITERIA
5. CAUSES OF AUTOCORRELATION
6. REMEDIAL MEASURES
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WHAT IS AUTOCORRELATION?
Ingeneral,autocorrelationmeansthecorrelationamongtheerrorterms.Ifitispresentinthe
estimatedmodel,itistheviolationofOLStechniqueandhence,theestimatedmodelcannotbe
usedforpredictionandforecasting.Thestructureofautocorrelationisasfollows:
Yt=β0+β1Xt+UtandwhereUt=ρUt1+vt
Ifρ=0,thenthereisnoserialcorrelation;otherwise,thereispresenceofserialcorrelation.The
rangeofρisbetween‐1and+1,indicatingperfectnegativeandpositiveautocorrelation.So,if
ρ≠0,itisautocorrelationandassumesthattheerrortermfollowstheautoregressivescheme.
CONSEQUENCES OF AUTOCORRELATION
The estimation process requires that OLS applications of estimated parameters should follow the
BLUE theorem. If not, there is question on model reliability. In specific, the presence of
autocorrelation makes the estimated parameters highly volatile and their standard errors are
infinite. However, it will not affect the unbiasedness property; but affects minimum variance
property.
DOES IT REALLY PROBLEM?
On the first instance, any estimated parameters whose value does not follow BLUE theorem
means it is really a problem. However, in the case of autocorrelation, it depends upon the
objective specification. If the objective is for prediction (or forecasting), then the existence of
autocorrelation (not in severe) is not a serious problem. But if the objective is model reliability,
then it is serious issue, even if it is at the minor level. So we assume that the disturbance term is
generated by a slightly different method and such error terms are also called the white noise error
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