# How to solve autocorrelation problem. 10.2 2022-10-15

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Autocorrelation, also known as serial correlation, is a statistical phenomenon that occurs when the residuals (prediction errors) of a time series model are correlated with its past values. This can lead to incorrect conclusions about the relationships between variables and can affect the accuracy of the model's forecasts.

There are several methods for addressing autocorrelation in time series data, including:

1. Differencing: One common method for addressing autocorrelation is to take the difference between consecutive observations (e.g. X(t) - X(t-1)). This can help to eliminate the correlation between the observations and may make the data more stationary, which is a requirement for many time series models.

2. ARIMA modeling: Autoregressive integrated moving average (ARIMA) models are a class of time series models that can account for autocorrelation in the data. These models include autoregressive (AR) and moving average (MA) terms that help to model the correlation between the observations.

3. Lagged variables: Another approach is to include lagged variables in the model. For example, if we are trying to predict the value of a variable at time t, we can include the values of the variable at times t-1, t-2, etc. as predictor variables in the model. This can help to capture the autocorrelation in the data and improve the model's forecast accuracy.

4. Interventions: In some cases, autocorrelation may be due to an external factor, such as a policy change or a natural disaster. In these cases, it may be necessary to include an intervention variable in the model to account for the effect of this factor on the time series.

5. Testing for autocorrelation: It is important to test for autocorrelation before implementing any of the above methods. There are several statistical tests that can be used to detect autocorrelation, such as the Durbin-Watson test or the Breusch-Godfrey test.

In summary, there are several methods that can be used to address autocorrelation in time series data. These include differencing, ARIMA modeling, lagged variables, interventions, and testing for autocorrelation. By using these methods, it is possible to improve the accuracy of time series forecasts and to draw more reliable conclusions about the relationships between variables.

## Ways to Overcome the Autocorrelation Problem However, the PACF may indicate a large partial autocorrelation value at a lag of 17, but such a large order for an autoregressive model likely does not make much sense. Yes, you can sometimes solve an autocorrelation problem in a regression model by adding a variable, if it's the right variable. Obtained by observing response variable at regular time periods. Thus, the influence of the omitted variable is similar from one time period to the next. Values close to 2 the middle of the range suggest less autocorrelation, and values closer to 0 or 4 indicate greater positive or negative autocorrelation respectively. Usually the measurements are made at evenly spaced times - for example, monthly or yearly. Chapter 21 points out how things change when one considers more realistic models for the data generating process.

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## Introductory Econometrics Chapter 20: Autocorrelation A time series is a sequence of measurements of the same variable s made over time. Forecast based only on past values, no other variables important. And if that is okay, which I can't see why it wouldn't be, then I don't understand why everyone doesn't just "solve" autocorrelation issues in regression by including an independent variable that 'captures' the non-independent nature of the trial structure. A time series is a sequence of observations on a variable over time. In a survey, for instance, one might expect people from nearby geographic locations to provide more similar answers to each other than people who are more geographically distant. The exploratory analysis was used to clean the data and determine factors to be used for the linear regression model. Compare the models and ACF plots below: You can see that in the first ACF plot, lag-1 is significant, and there is a clear decreasing trend, whereas in the second the lag-1 is tiny and there is no obvious trend.

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## Autocorrelation However, autocorrelation can also occur in cross-sectional data when the observations are related in some other way. Thus, an AR 1 model would likely be feasible for this data set. The introduction of autocorrelation into data might also be caused by incorrectly defining a relationship, or model misspecification. The advantage of the former method is that it is not necessary to know the exact nature of the heteroskedasticity or autocorrelation to come up with consistent estimates of the SE. Then I saw that if I remove a certain independent variable, namely the session itself, then I do see serious autocorrelation.

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## How to handle autocorrelation For example, if you are attempting to model a simple linear relationship but the observed relationship is non-linear i. Forecasts are extensively used to support business decisions and direct the work of operations managers. The plot below gives a time series plot for this dataset. The test statistics are calculated with the following formula. With your adjusted standard errors, you can compute new t statistics and perform any hypothesis testing you need to do. Time series econometrics is a huge and complicated subject. For lag 0 the 100% partial autocorrelation is obvious but for lag 1 also the partial autocorrelation is very high.

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## AutoCorrelation WAYS TO OVERCOME THE AUTOCORRELATION PROBLEM Several approaches to data analysis can be used when autocorrelation is present. A lag 1 autocorrelation i. Tips for Fixing Autocorrelation The first step to fixing time-dependency issues is usually to identify omission of a key predictor variable in your analysis. If adding a time trend results in there not being any detectable autocorrelation, is there any reason to adjust the standard errors or use ARIMA model, etc? In the results below we see that the lag-3 predictor is significant at the 0. A static model deals with the contemporaneous relationship between a dependent variable and one or more independent variables.

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## 10.2 A few other variables, such as the gross domestic product GDP index instead of household income can be experimented with. We will analyze the dataset to identify the order of an autoregressive model. However, in my regression model I see no signs of autocorrelation in the residuals-- either when looking at an ACF plot or when using the Durbin-Watson test. In the case we are considering, the error term reflects omitted variables that influence the demand for cigarettes. Why does autocorrelation happen? For example, instead of only one lag of the dependent in the model, more lag of the dependent variables can be experimented, as the value one year ago may be more important than the value one quarter ago. Next, check to make sure you havent misspecified your modelfor example, you may have modeled a linear relationship as exponential. Unfortunately, we cannot be so cavalier with another key assumption of the classical econometric model: the assertion that the error terms for each observation are independent of one another.

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## regression This phenomenon is known as autocorrelation or serial correlation and can sometimes be detected by plotting the model residuals versus time. For example, suppose a researcher develops a regression forecasting model that attempts to predict sales of new homes by sales of used homes over some period of time. I am told that with such data this is a single participant case study autocorrelation is expected to be a problem, and so we should 'worry' about it and try to account for it. The more close it to 4, the more signs of negative autocorrelation. Adding this variable to the regression model might significantly reduce the autocorrelation. In terms of suggesting whether to add a variable or not, I don't have a very good sense of what these variables are.

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## Finding and Fixing Autocorrelation After an extensive literature review and consultations with experts in this field, the following actions can experimented to reduce the autocorrelations. One common way for the "independence" condition in a multiple linear regression model to fail is when the sample data have been collected over time and the regression model fails to effectively capture any time trends. Statistical software such as SPSS may include the option of running the Durbin-Watson test when conducting a regression analysis. Generally, any usage has a tendency to remain in the same state from one observation to the next. By default, xtabond2 applies the system GMM. This violation of the classical econometric model is generally known as autocorrelation of the errors. These considerations apply quite generally.

Next Most forecasting books are likely to have an example. Log form or exponential form may or may not make improvements. We next look at a plot of partial autocorrelations for the data: Here we notice that there is a significant spike at a lag of 1 and much lower spikes for the subsequent lags. Then by calculating the correlation of the transformed time series we obtain the partial autocorrelation function PACF. The ACF is a way to measure the linear relationship between an observation at time t and the observations at previous times.

Next In this chapter, we analyze autocorrelation in the errors and apply the results to the study of static time series models. For example, the error term in year t are correlated with the error term in year t-1. As is the case with heteroskedasticity, OLS estimates remain unbiased, but the estimated SEs are biased. The test for AR 1 process in first differences usually rejects the null hypothesis, if the first lag of dependent variable is used. Most of these variables may proved not to be adding any more value to the model specifications. In many ways our discussion of autocorrelation parallels that of heteroskedasticity. In a regression analysis, autocorrelation of the regression residuals can also occur if the model is incorrectly specified.

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