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collection of time indices 1 t1 < < tm the

joint distribution of (xt1, , xtm) is the same as

that of (xt1+h, xtm+h) for h 1

Thus, stationarity implies that the xts are

identically distributed and that the nature of

any correlation between adjacent terms is the

same across all periods

Economics 20 - Prof.

A stochastic process is covariance stationary

if E(xt) is constant, Var(xt) is constant and for

any t, h 1, Cov(xt, xt+h) depends only on h

and not on t

Thus, this weaker form of stationarity

requires only that the mean and variance are

constant across time, and the covariance just

depends on the distance across time

Economics 20 - Prof.

A stationary time series is weakly

dependent if xt and xt+h are almost

independent as h increases

If for a covariance stationary process

Corr(xt, xt+h) 0 as h , well say this

covariance stationary process is weakly

dependent

Want to still use law of large numbers

Economics 20 - Prof.

An MA(1) Process

A moving average process of order one

[MA(1)] can be characterized as one where

xt = et + 1et-1, t = 1, 2, with et being an

iid sequence with mean 0 and variance 2e

This is a stationary, weakly dependent

sequence as variables 1 period apart are

correlated, but 2 periods apart they are not

Economics 20 - Prof.

An AR(1) Process

An autoregressive process of order one

[AR(1)] can be characterized as one where

yt = yt-1 + et , t = 1, 2, with et being an

iid sequence with mean 0 and variance e2

For this process to be weakly dependent, it

must be the case that || < 1

Corr(yt ,yt+h) = Cov(yt ,yt+h)/(yy) = 1h

which becomes small as h increases

Economics 20 - Prof.

Trends Revisited

A trending series cannot be stationary,

since the mean is changing over time

A trending series can be weakly dependent

If a series is weakly dependent and is

stationary about its trend, we will call it a

trend-stationary process

As long as a trend is included, all is well

Economics 20 - Prof.

Linearity and Weak Dependence

A weaker zero conditional mean

assumption: E(ut|xt) = 0, for each t

No Perfect Collinearity

Thus, for asymptotic unbiasedness

(consistency), we can weaken the

exogeneity assumptions somewhat relative

to those for unbiasedness

Economics 20 - Prof.

Large-Sample Inference

Weaker assumption of homoskedasticity:

Var (ut|xt) = 2, for each t

Weaker assumption of no serial correlation:

E(utus| xt, xs) = 0 for t s

With these assumptions, we have

asymptotic normality and the usual standard

errors, t statistics, F statistics and LM

statistics are valid

Economics 20 - Prof.

Random Walks

A random walk is an AR(1) model where

1 = 1, meaning the series is not weakly

dependent

With a random walk, the expected value of

yt is always y0 it doesnt depend on t

Var(yt) = e2t, so it increases with t

We say a random walk is highly persistent

since E(yt+h|yt) = yt for all h 1

Economics 20 - Prof.

A random walk is a special case of whats

known as a unit root process

Note that trending and persistence are

different things a series can be trending

but weakly dependent, or a series can be

highly persistent without any trend

A random walk with drift is an example of

a highly persistent series that is trending

Economics 20 - Prof.

10

In order to use a highly persistent series

and get meaningful estimates and make

correct inferences, we want to transform it

into a weakly dependent process

We refer to a weakly dependent process as

being integrated of order zero, [I(0)]

A random walk is integrated of order one,

[I(1)], meaning a first difference will be I(0)

Economics 20 - Prof.

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