Dougherty C12G03 2016 05 22

Type author name/s here
Dougherty
Introduction to Econometrics,
5th edition
Chapter heading
Chapter 12: Autocorrelation
© Christopher Dougherty, 2016. All rights reserved.

TESTS FOR AUTOCORRELATION I: BREUSCH–GODFREY TEST
Simple autoregression of the residuals
ut  ut 1   t
uˆ t   uˆ t 1  error
We will initially confine the discussion of the tests for autocorrelation to its most common
form, the AR(1) process. If the disturbance term follows the AR(1) process, it is reasonable
to hypothesize that, as an approximation, the residuals will conform to a similar process.
1
ut  ut 1   t
After all, provided that the conditions for the consistency of the OLS estimators are
satisfied, as the sample size becomes large, the OLS estimators will converge on their true
values.
2
ut  ut 1   t
If the OLS estimators will converge on their true values, the location of the regression line
will converge on the true relationship, and the residuals will coincide with the values of the
disturbance term.
3
ut  ut 1   t
Hence a regression of uˆ t on uˆ t 1 is sufficient, at least in large samples. Of course, there is

the issue that, in this regression, uˆ t 1 is a lagged dependent variable, but that does not
matter in large samples.
4
true value
Yt  10  2.0t  ut
T = 200
ut  0.7 ut 1   t
uˆ t  ˆ uˆ t 1 5
T = 100
T = 50
T = 25
0
-0.5 0 0.5 0.7 1 ̂
This is illustrated with the simulation shown in the figure. The true model is as shown, with
ut being generated as an AR (1) process with r = 0.7.
5
true value
Yt  10  2.0t  ut
T = 200
ut  0.7 ut 1   t
uˆ t  ˆ uˆ t 1 5
T = 100
T = 50
T = 25
0
-0.5 0 0.5 0.7 1 ̂
The values of the parameters in the model for Yt make no difference to the distributions of
the estimator of r.
6
true value
Yt  10  2.0t  ut
T = 200
ut  0.7 ut 1   t
uˆ t  ˆ uˆ t 1 5
T mean
T = 100 25 0.47
50 0.59
T = 50 100 0.65
200 0.68
T = 25
0
-0.5 0 0.5 0.7 1 ̂
As can be seen, when uˆ t is regressed on uˆ t 1 , the distribution of the estimator of r is left

skewed and heavily biased downwards for T = 25. The mean of the distribution is 0.47.
7
true value
Yt  10  2.0t  ut
T = 200
ut  0.7 ut 1   t
uˆ t  ˆ uˆ t 1 5
T mean
T = 100 25 0.47
50 0.59
T = 50 100 0.65
200 0.68
T = 25
0
-0.5 0 0.5 0.7 1 ̂
However, as the sample size increases, the downwards bias diminishes and it is clear that
the distribution of the estimator is converging on 0.7 as the sample becomes large.
Inference in finite samples will be approximate, given the autoregressive nature of the
regression. 8
Breusch–Godfrey test
k
Yt   1    j X jt  ut
j 2
The simple estimator of the autocorrelation coefficient depends on Assumption C.7 part (2)
being satisfied when the original model (the model for Yt) is fitted. Generally, one might
expect this not to be the case.
9
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
If the original model contains a lagged dependent variable as a regressor, or violates

Assumption C.7 part (2) in any other way, the estimates of the parameters will be
inconsistent if the disturbance term is subject to autocorrelation.
10
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
As a repercussion, a simple regression of uˆ t on uˆ t 1 will produce an inconsistent estimate

of r. The solution is to include all of the explanatory variables in the original model in the
residuals autoregression.
11
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
If the original model is the first equation where, say, one of the X variables is Yt–1, then the
residuals regression would be the second equation.
12
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
The idea is that, by including the X variables, one is controlling for the effects of any
endogeneity on the residuals.
13
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
The underlying theory is complex and relates to maximum-likelihood estimation, as does

the test statistic. The test is known as the Breusch–Godfrey test.
14
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
Test statistic: nR2, distributed as c2(1) when

testing for first-order autocorrelation
Several asymptotically-equivalent versions of the test have been proposed. The most
popular involves the computation of the lagrange multiplier statistic nR2 when the residuals
regression is fitted, n being the actual number of observations in the regression.
15
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
Test statistic: nR2, distributed as c2(1) when

testing for first-order autocorrelation
Asymptotically, under the null hypothesis of no autocorrelation, nR2 is distributed as a chi-

squared statistic with one degree of freedom.
16
k
Yt   1    j X jt  ut
j 2
k
uˆ t   1    j X jt   uˆ t 1
j2
Alternatively, simple t test on coefficient of uˆ t 1
A simple t test on the coefficient of uˆ t 1 has also been proposed, again with asymptotic
validity.
17
k
Yt   1    j X jt  ut
j 2
k q
uˆ t   1    j X jt    s uˆ t  s
j2 s 1
The procedure can be extended to test for higher order autocorrelation. If AR(q)
autocorrelation is suspected, the residuals regression includes q lagged residuals.
18
k
Yt   1    j X jt  ut
j 2
k q
uˆ t   1    j X jt    s uˆ t  s
j2 s 1
Test statistic: nR2, distributed as c2(q)
For the lagrange multiplier version of the test, the test statistic remains nR2 (with n smaller
than before, the inclusion of the additional lagged residuals leading to a further loss of
initial observations).
19
k
Yt   1    j X jt  ut
j 2
k q
uˆ t   1    j X jt    s uˆ t  s
j2 s 1
Test statistic: nR2, distributed as c2(q)
Under the null hypothesis of no autocorrelation, nR2 has a chi-squared distribution with q
degrees of freedom.
20
k
Yt   1    j X jt  ut
j 2
k q
uˆ t   1    j X jt    s uˆ t  s
j2 s 1
Alternatively, F test on the lagged residuals

H0: r1 = ... = rq = 0, H1: not H0
The t test version becomes an F test comparing RSS for the residuals regression with RSS
for the same specification without the residual terms. Again, the test is valid only
asymptotically.
21
k
Yt   1    j X jt  ut
j 2
k q
uˆ t   1    j X jt    s uˆ t  s
j2 s 1
Test statistic: nR2, distributed as c2(q),

valid also for MA(q) autocorrelation
The lagrange multiplier version of the test has been shown to be asymptotically valid for
the case of MA(q) moving average autocorrelation.
22
Copyright Christopher Dougherty 2016.
These slideshows may be downloaded by anyone, anywhere for personal use.

Subject to respect for copyright and, where appropriate, attribution, they may be
used as a resource for teaching an econometrics course. There is no need to
refer to the author.
The content of this slideshow comes from Section 12.2 of C. Dougherty,

Introduction to Econometrics, fifth edition 2016, Oxford University Press.
Additional (free) resources for both students and instructors may be
downloaded from the OUP Online Resource Centre
http://www.oxfordtextbooks.co.uk/orc/dougherty5e/.
Individuals studying econometrics on their own who feel that they might benefit
from participation in a formal course should consider the London School of
Economics summer school course
EC212 Introduction to Econometrics
http://www2.lse.ac.uk/study/summerSchools/summerSchool/Home.aspx
or the University of London International Programmes distance learning course
20 Elements of Econometrics
www.londoninternational.ac.uk/lse.
2016.05.22

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© Christopher Dougherty, 2016. All rights reserved.

Simple autoregression of the residuals

Simple autoregression of the residuals

Simple autoregression of the residuals

Simple autoregression of the residuals

Hence a regression of uˆ t on uˆ t 1 is sufficient, at least in large samples. Of course, there is

Simple autoregression of the residuals

Simple autoregression of the residuals

Simple autoregression of the residuals

As can be seen, when uˆ t is regressed on uˆ t 1 , the distribution of the estimator of r is left

Simple autoregression of the residuals

If the original model contains a lagged dependent variable as a regressor, or violates

As a repercussion, a simple regression of uˆ t on uˆ t 1 will produce an inconsistent estimate

The underlying theory is complex and relates to maximum-likelihood estimation, as does

Test statistic: nR2, distributed as c2(1) when

Test statistic: nR2, distributed as c2(1) when

Asymptotically, under the null hypothesis of no autocorrelation, nR2 is distributed as a chi-

Alternatively, simple t test on coefficient of uˆ t 1

Test statistic: nR2, distributed as c2(q)

Test statistic: nR2, distributed as c2(q)

Alternatively, F test on the lagged residuals

Test statistic: nR2, distributed as c2(q),

These slideshows may be downloaded by anyone, anywhere for personal use.

The content of this slideshow comes from Section 12.2 of C. Dougherty,

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