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Autocorrelation,

Box Jenkins or ARIMA


Forecasting
Autocorrelation and the Durbin-
Watson Test
An autocorrelation is a correlation of the values of a variable with values of the same variable
lagged one or more periods back. Consequences of autocorrelation include inaccurate estimates
of variances and inaccurate predictions.

Lagged Residuals
The Durbin-Watson test (first-order autocorrelation):
i i i-1 i-2 i-3 i-4 H0: 1 = 0
1 1.0 * * * * H1: 0
2 0.0 1.0 * * *
3 -1.0 0.0 1.0 * * The Durbin-Watson test statistic:
4 2.0 -1.0 0.0 1.0 *
5 3.0 2.0 -1.0 0.0 1.0
6 -2.0 3.0 2.0 -1.0 0.0 n 2
7 1.0 -2.0 3.0 2.0 -1.0
( ei ei 1 )
d i2 n
8 1.5 1.0 -2.0 3.0 2.0
9 1.0 1.5 1.0 -2.0 3.0
10 -2.5 1.0 1.5 1.0 -2.0
2
ei
i 1
DW d Test

4 Steps

Step 1: Estimate Yi 1 2 X 2i 3 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 - dU 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
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
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
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
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
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
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
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. Banners 5 159 5.4
market for the special chair is the 6 160 5.3
Carolinas, Florida and Arizona, 7 147 5.5
areas where there are many senior 8 147 5.7
citizens and retired people The
9 152 5.9
president of Banner Rocker is
studying the association between 10 160 6.2

his advertising expense (X) and the 11 169 6.3

number of rockers sold over the last 12 176 5.9

20 months (Y). He collected the 13 176 6.1


following data. He would like to use 14 179 6.2
the model to forecast sales, based 15 184 6.2
on the amount spent on advertising, 16 181 6.5
but is concerned that because he 17 192 6.7
gathered these data over 18 205 6.9
consecutive months that there
19 215 6.5
might be problems of
20 209 6.4
autocorrelation.
Durbin-Watson Test for Autocorrelation: An Example

Step 1: Generate the regression


equation
Durbin-Watson Test for Autocorrelation: An Example

The resulting equation is: = - 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 ( = 0)
H1: Positive residual correlation ( > 0)

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


dl=1.20 du=1.41

Reject H0
Positive Autocorrelation Fail to reject H0
Inconclusive No Autocorrelation

dl=1.20 du=1.41

(e e t t 1 )2
2338.5829
d t 2
n
0.8522
(e ) 2 2744.2685
t
t 1
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 seriesthat 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 cant 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.

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