A transformation that will circumvent the problem of autocorrelation in an error-component model (Q1176603)

This paper derives a simple transformation which will transform serially correlated error-components disturbances into spherical disturbances. Although \(\Omega\) and \(\Omega^{-1}\) are well known in the literature the derivation of \(\Omega^{-1/2}\) has many advantages: (i) It transforms GLS into a WLS procedure and, therefore, simplifies the computation. (ii) It provides natural estimates of the variance components. (iii) The transformation obtained can be easily extended to handle more general error processes on the remainder disturbances. This is illustrated for the AR(1) model, AR(2) model, and the specialized AR(4) model for quarterly data.