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What does a correlogram describe? And, in particular, how should I interpret these two correlograms? Thanks

correlogram of 100*ln(dividend yield)

correlogram of excess returns

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  • $\begingroup$ How many lags can i include in arima if first amd fourth bubble are outside shaded area $\endgroup$
    – esr
    Mar 10, 2023 at 13:30

1 Answer 1

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On the y axis is the autocorrelation. The x axis tells you the lag. So, if x=1 we are looking at the correlation of December with November, November with October, etc. If x=2, we have a lag of 2 and we are looking at the correlation of December with October, November with September, etc.

In the first graph, there are high positive correlations that only slowly decline with increasing lags. This indicates a lot of autocorrelation and you will need to take that into account in your modeling.

In the second graph, the correlations are very low (the y axis goes from +.10 to -.10) and don't seem to have a pattern.

The gray areas are confidence bands (e.g. tell you whether the correlation is statistically significant).

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