FRM Part I · FRM Exam Part I · Regression Diagnostics
An analyst regresses monthly excess returns of a fund on a market factor using 120 observations. The Durbin-Watson statistic for the residuals is 2.00 approximately. Which conclusion is most appropriate?
A Durbin-Watson statistic near 2 means the first-order residual autocorrelation is close to zero, since DW is roughly 2 times (1 minus rho). So there is little evidence of serial correlation. Values near 0 signal positive and near 4 signal negative autocorrelation.
- AThe residuals show strong positive first-order autocorrelation
- BThe residuals show strong negative first-order autocorrelation
- CThe residuals show little evidence of first-order autocorrelationCorrect
- DThe regression coefficients are biased because of serial correlation
Explanation
The Durbin-Watson statistic is approximately 2(1 - rho), where rho is the first-order residual autocorrelation. A value near 2 implies rho near 0, so there is little evidence of first-order autocorrelation. Values near 0 indicate positive and near 4 negative autocorrelation. Autocorrelation does not bias OLS coefficients anyway, so option D is also wrong.
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