Econometrics1

Lecture 6

Contents
Time series analysis
Stationarity
What it is and what it is for

Some basic time series models

Autoregressive (AR)
Moving average (MA)

Consequences of non-stationarity (spurious regress

ion)
Testing for (non)-stationarity
Dickey-Fuller test
Augmented Dickey-Fuller test

Cointegration

What is time series data

A time series is any series of data that va
ries over time. For example

Monthly Tourist Arrivals from Korea

Quarterly GDP of Laos
Hourly price of stocks and shares
Weekly quantity of beer sold in a pub

Because of widespread availability of time

series databases most empirical studie
s use time series data.

(Weak) Stationarity

Examples of Times Series Models

Is MA and AR process stationary?

Example of Stationary Time Series

Another Example of Stationary Time Series

Example of Non-stationary Time Series

Non-stationary time series

Example of Non-stationary Time Series

Non-stationary time series -correlogram

Stata command: corrgram y, lags(7)

Possible solutions of non-stationarity

Stata Difference Operator

Stationary time series - correlogram

Non-stationary Time Series Continued Random Walk

Random walk

Relationship between stationary and non- stationary process

Summary on basic time series processes

What is a Spurious Regression

A Spurious or Nonsensical relationship
may result when one Non-stationary tim
e series is regressed against one or mor
e Non-stationary time series

Spurious Regression

How to avoid spurious regression: 3 approaches to non-stationarity

How do we identify non-stationary processes?

Informal Procedure To Identify Stationary Process

Informal Procedure To Identify Stationary Process

Informal Procedure To Identify Stationary Process

Dickey-Fuller Test

Augmented Dickey-Fuller Test

Critical values ADF

Critical Values of ADF tests are not equal
to t critical values!
DF/ADF use t- and F-statistics but critical val
ues are not standard
Problems:
distributions of these statistics are non-standard
special tables of critical values (derived from nume
rical simulations)
Usual t- and F-tests not valid in presence of unit ro
ots

DF test- Stata

Engle-Granger Approach to Cointegrati

on
This is essentially a bi-variate approach an
d is based on the Augmented Dickey-Fuller
test for stationarity.
If we have two non-stationary variables con
taining a unit root (i.e. I(1) variables), then
we describe them as being cointegrated if
the error term is stationary (i.e. I(0)).
We test for the stationarity of the error ter
m using the ADF test in the same way as th
e individual variables.

Cointegration
When we have an I(0) error term, with tw
o I(1) variables, in effect the drift proces
s in the I(1) variables have cancelled eac
h other out to produce an error term wit
h no drift.
If there is evidence of cointegration bet
ween X and Y, we say that there is a lon
g-run equilibrium relationship betwee
n X and Y

Potential Problem- Cointegrati

on
The ADF test often indicates acceptance of the nul
l hypothesis (no cointegration), when in fact cointe
gration is present
The ADF test is best when we have a long time spa
n of data, rather than large amounts of observation
s over a short time span. This can be a problem wit
h financial data which tends to cover a couple of y
ears, but with high frequency data (i.e. daily data)
It is only really used for bi-variate cointegration tes
ts, although it can be used for multivariate models,
a different set of critical values is required.

Cointegration - Stata