medium · FRM Part 1 Quantitative Analysis
An analyst is concerned that a time-series regression of equity returns on interest rates suffers from positive serial correlation in the residuals.
If the analyst ignores this and uses standard OLS, what is the most likely impact on the hypothesis tests for the coefficients?
- Standard errors will be understated, leading to overinflated t-statistics and frequent Type I errors.
- Standard errors will be overstated, making it too difficult to reject the null hypothesis in most cases.
- The coefficient estimates themselves will become biased and statistically inconsistent under OLS.
- The R² will be systematically and predictably lower than the true population value in this setting.
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