What is Autocorrelation?

Autocorrelation is a mathematical representation of the degree of

similarity between a given time series and a lagged version of itself over
successive time intervals. It is the same as calculating the correlation
between two different time series, except autocorrelation uses the same
time series twice: once in its original form and once lagged one or more
time periods.
Autocorrelation is where error terms in a time series transfer from one period to another. In
other words, the error for one time period a is correlated with the error for a subsequent time
period b. For example, an underestimate for one quarter’s profits can result in an
underestimate of profits for subsequent quarters. This can give various problems,
including:
 Inefficient Ordinary Least Squares Estimates and any forecast based on those estimates.
An efficient estimator gives you the most information about a sample; inefficient
estimators can perform well, but require much larger sample sizes to do so.
 Exaggerated goodness of fit (for a time series with positive serial correlation and
an independent variable that grows over time).
 Standard errors that are too small (for a time series with positive serial correlation and an
independent variable that grows over time).
 T-statistics that are too large.
 False positives for significant regression coefficients. In other words, a regression
coefficient appears to be statistically significant when it is not.

Overcome

There are various ways in dealing with autocorrelation. Some most common are
(a) Include dummy variable in the data.
(b) Estimated Generalized Least Squares
(c) Include a linear (trend) term if the residuals show a consistent increasing or
decreasing pattern

Leasing

We define lease in order to understand the leasing contract. The lease is a contract whereby
one party, the lessor, grants the right to use a particular good for a period of time to the other
party, the lessee (or tenant), which will pay for the transfer of the right to use a fixed amount
regularly .
Forecast step by step

Monte Carlo experiment is an alternative method how to generate new sample from historical data.
The key difference is that the sample is generated in Monte Carlo simulation by drawing from a
hypothesised analytical distribution (Hull, 2012; Bohdalová and Šlahor, 2008). Thus, Monte Carlo
experiment is convenient to use in cases when the true distribution of the underlying data is known.
The main advantage of this method is then that replicated sample follows the same distributional
properties as the original data. In the reality, the distribution is rarely known (Tsay, 2010; Bohdalová,
2006). Employing wrong assumption about the distribution invalidates the experiment.

The general formula, which can be employed for the Monte Carlo experiment is following: 𝑃𝑡 =
𝑃𝑡−1𝑒 (𝑈+𝑆𝐸∗𝜎) (3) where Pt is stock price today and Pt-1 is stock price yesterday, U is drift (or
constant) SE is standard error and 𝜎 is random shock with normal distribution. Term SE*𝜎 is well
known Wiener process, which is the indicator of random walk. The constant can be obtained from
linear regression and also the standard error. Since 𝜎 is randomly generate from normal distribution,
there is incorporate the assumption of normal distribution. The assumption about the normality is a
crucial part for successful Monte Carlo experiment. Distribution can be tested by Jarque-Bera (JB)
test of normality. If the assumption about the distribution was correct, the simulation can be
repeated many time and average values can be considered as statistically powerful new sample.