Regression: Advanced Topics
When residual analysis shows that the residuals are correlated, then one of the key assumptions of the linear model does not hold, and tests and confidence intervals based on this assumption are invalid and cannot be trusted. Fortunately, there is a solution to this problem: Replace the assumption of independent noise by the weaker assumption that the noise process is station- ary but possibly correlated. One could, for example, assume that the noise is an ARMA process. This is the strategy we will discuss in this section.
KeywordsCredit Card Forward Rate Market Maker Default Probability Bond Price
Unable to display preview. Download preview PDF.