Type I Spurious Regression in Econometrics

Abstract

In applied econometrics researchers often infer the relation among nonstationary time series by regression of their differences. The aim of this paper is to show that in some circumstances regression of differenced time series tends to reject the relation among their levels. This phenomenon is known as type I spurious regression. Time series are dynamic processes, and the ignored system dynamics will become the systematic errors in regression equations. Differencing does not preserve the underlying relation among time series in regression due to systematic errors. This paper will outline how regression of differenced time series tends to reject the relation between their levels, and so potentially to incur type I spurious regression.