Multicollinearity Problems in Modeling Time Series with Trading-Day Variation

Author(s): Teresita S. Salinas and Steven C. Hillmer

Source: Journal of Business & Economic Statistics, Vol. 5, No. 3 (Jul., 1987), pp. 431-436
Published by: American Statistical Association
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? 1987 American Statistical Association Journalof Business&EconomicStatistics,July1987,Vol.5, No.3

MulticollinearityProblems in Modeling
Time Series With Trading-DayVariation
Teresita S. Salinas
Schoolof Business,Washburn Topeka,KS 66621
University,
Steven C. Hillmer
of Kansas,Lawrence,KS 66045
Schoolof Business,University

Thisarticlediscussesthemulticollinearity
problems associatedwiththeestimation
oftimeseries
modelsinfluenced bytrading-day Ananalysisof the designmatrixis performed,
variation. and
are computed.The characteristics
measuresof the degreeof multicollinearity of the design
matrix of a popular arealsoanalyzed,anditis shownthatinsomecases use
parameterization
of thisreparameterization alleviatesthe multicollinearity
significantly problem.
indexes;Variance
KEYWORDS:Condition decomposition
proportions;
Eigenvalues.

1. INTRODUCTION
Manytime series that are reportedmonthlyand that
represent monthly totals (flow series) contain effects
caused by the compositionof the calendar.This phe-
nomenonis knownas trading-day variation.Young(1965)
defined trading-dayvariationas the monthlyvariation
in a series causedby within-monthvariationor calendar
composition. Examples of monthly series that may be
affectedby trading-dayvariationcan be found in retail
sales, wholesale sales, and levels of activitiesin service
industries,among others.
Several authors (e.g., Bell and Hillmer 1983) have
shownthat attemptsto model series affectedby trading
day effects usingpure autoregressiveintegratedmoving
average (ARIMA) models may lead to unsatisfactory
results. Liu (1980), Hillmer (1982), Bell and Hillmer
(1983), and Cleveland and Grupe (1983) considered
using a regression model with ARIMA errors when
modeling series containingtrading-dayeffects. In this
article,we follow Bell and Hillmer(1983), who consid-
ered the model
Z, = TD, + N,, TDt = E PiXti,
i=l
Z = Xp + N, (1)
where Z, is the observed series, Z = (Z, ... Z,)',
, but the estimatesof the f's are highlycorrelatedamong
N = (N1, ..., Nn)', and 1 = (],l, . . . , 7)'. TD,t
representsthe trading-daycomponent with X,i being
the number of times the day-of-the-weeki occurs in
month t, X is an n x 7 matrixwhose tth row is (X,1,
. . . , Xt7), and fi (i = 1, . . . , 7) are parameters to be
estimated.Ntis a noisetermfollowingan ARIMA model
of the form
O(B)6(B)N, = 0(B)a,,
where a, is white noise; +(B), 6(B), and 0(B) are poly-
nomials of the backshiftoperator B with no common
roots; and the zeros of 4(B) and 0(B) lie outside the
unit circle, whereas the zeros of 6(B) are on the unit
circle. Bell and Hillmer (1983) discussed methods to
identifyand estimatemodels in (1) from monthlydata.
In this article we will study the design matrixX as-
sociated with the trading-daypart of model (1) and
investigatethe natureof the multicollinearityassociated
with that matrix.To illustratewhy this is an important
consideration,considerthe time seriesof the logarithms
of nationwidemonthlywholesale dollar sales of paper
and paper productsin the United States from January
1967to November1979.These datawere obtainedfrom
the U.S. Bureau of the Census, and characteristicsof
the trading-daypart of this time series is similarto that
of many other time series that we have studied. Fol-
lowing Bell and Hillmer (1983), the model
7
=? yt + (1 - 012B12)
z, = f ixti + - )(1 - a.t (2)
i=1 S (1S'2)
was identified and estimated for this time series. The
correlationmatrixof the parameterestimatesobtained
from the 1981 BMDP time series programis reported
in Table 1. ObservefromTable 1 that, as expectedfrom
theoretical considerations(see Pierce 1971), the esti-
mate of 012 is uncorrelatedwith estimates of the f's,
themselves.
This exampleillustratesthat the potentialof a prob-
lem with multicollinearityexistsfor this set of data. The
purpose of this article is to investigate the structure
implicitin the designmatrixX to betterunderstandthe
nature of this problem. In this analysiswe show that
the multicollinearityproblemwill generallyoccurin the
analysisof time series influencedby trading-dayvari-

431
432 Journalof Business & EconomicStatistics,July 1987

Table 1. CorrelationMatrixof ParameterEstimatesFromModel (2)

012 11 (2 (3 (4 5 A f7

012 1.000
fi, -.032 1.000
(2 -.016 .888 1.000
(3 .001 .916 .884 1.000
(4 -.041 .938 .917 .887 1.000
f5 -.014 .924 .939 .911 .886 1.000
36 -.010 .924 .930 .935 .918 .883 1.000
fi7 -.013 .885 .925 .928 .937 .922 .887 1.000

ation and that a common reparameterizationhelps to
alleviate this problem.
RESULTS
2. PRELIMINARY
In situationsin which the noise model in Equation
(1) is nonstationary[6(B) # 1] the usual approachin-
volves estimationof the parametersbased on the dif-
so that there exists a p x 1 vector w 7 0 such that
A'Aw = 0 and w'A'Aw = 0, implying alw = 0 for all
i. These in turn imply R'Rw = 0, which means that
R'R is singular. Conversely, if R'R is singular, then
there exists a vector w : 0 such that R'Rw = 0, which
implies that
m

ferenced time series ((B)Z, using differencedtrading- w'A'Aw + (n, - l)w'aia/w = 0.

day variables6(B)Xit. The model that is estimatedbe-
comes
7
O(B)
5(B)Z, = fli[(B)Xti] + (B)
i=1 4(B)
Therefore,the designmatrixcorrespondingto any par-
ticulartime serieswill be dependenton the differencing
operator6(B) in N,. In this articlewe will study prop-
erties of the design matrix Xo, the matrix whose ith
column contains elements ((B)Xti = Xti - 1X(t_1)i -
..* - 6dX(t-d)i[d is the degree of the polynomial 6(B)].
We will restrictour studyto the cases in which 5(B) =
1, 6(B) = (1 - B), 6(B) = (1 - B12), and S(B) =
(1 - B)(1 - B12), because these are the most common
degrees of differencingwe expect to find in series in-
fluenced by trading-dayeffects. We also restrict our
study to the situationin which
7 monthsprecedingthe ith month.For instance,if S(B) =
6(B)Zt = f,i[((B)Xti] + at
i=i
so that the series 6(B)Zt follows a multiple-regression
model. The model in (4) may not be appropriatefor
many time series affected by trading-dayvariation;
however, the analysis of (4) is a startingpoint from
which a general understandingof the problemcan be
obtained.
In our analysisof the design matrixassociatedwith
(4), we will make use of the followinglemma.
Lemma. Let A be a real m x p matrixwith rows
a' (i = 1,.. ,m). Let R be a k x p matrix(k _ m)
whose rows are the rows of A with al appearingni 2
1 times in R. Then (a) R'R = A'A +
l)aial, and (b) R'R is singulariff A'A is singular.
Proof. (a) is proved by the results from the prop-
erties of multiplicationof partitionedmatricesand the
fact that changingthe order of the rows in R does not
affect R'R. To show (b), assume that A'A is singular
i=l
Both terms of this sum are nonnegativenumbers,im-
plying that w'A'Aw = 0; thus A'A is singular.
a,. (3)
3. ANALYSISOF THE DESIGN MATRIX
The design matrixX6 in (4) is derivedfrom the dif-
ferencingoperator6(B) and fromthe characteristicsof
the Gregoriancalendar.It is well known that months
vary in length, and the composition of each type of
monthvariesfrom year to year. Young (1965) gave the
22 differenttypes of months that occur in the 28-year
cycle of the calendar. (The cycle is broken at the be-
ginningof each centurynot divisibleby 400.)
The ith row of the designmatrixX6 consistsof seven
numbersthat dependon the differencingoperator6(B)
and the compositionof the ith month and possiblythe
(4) 1, each row of X6 will consist of the numbers4 and 5,
dependingon how manyof each type of day there is in
the month corresponding to that row. If 6(B) = 1 -
B or (1 - B12), each rowof XOwill containthe numbers
-1, 0, or 1. If 5(B) = (1 - B)(1 - B12), each row of
X6 will comprisethe numbers -2, -1, 0, 1, or 2. All
of the possiblerowswere reportedby Young(1965)for
the case 5(B) = 1 and by Salinas (1983) for the case
((B) = (1 - B), (1 - B12), and (1 - B)(1 - B12).
Let Tb denote the matrix of the different possible
rows of X6 for a given b(B) with each possibilityap-
pearingonly once. Then, basedon the lemmain Section
2, the rankof Xo is the numberof nonzeroeigenvalues
of the matrixTET^.If all of these eigenvaluesare non-
;m= (ni- zero, then X'Xb is nonsingular.The eigenvalues of
T'T3 for selected values of 6(B) are reportedin Table
2. Based on a principal-componentsinterpretationof
the variationin the seven trading-dayvariables,the sum
of the eigenvaluesrepresentsthe total amountof vari-
ation in these variables.Based on these results, if the
 Salinas and Hillmer:Multicollinearity
full 28 trading-day-year cycle is included in the data,
the matrix X6 will have full rank for any choice of 6(B)
considered. In particular, if 6(B) = 1, there is one
extremely large eigenvalue with the other eigenvalues
being very small, so in this case one linear combination
of the variables accounts for about 99% of the variation
in the trading-day factors and would be the major factor
in capturing the effect of the trading-day variables. If
6(B) = (1 - B)(1 - B'2), there is one eigenvalue that
is smaller than the other six eigenvalues, so six linear
combinations account for about 99% of the variation
in the trading-day variables.
In practice, it is rare for one to have 28 years of
consistently defined data, so the practical significance
of the results in Table 2 is not clear. It can be verified
that each of the different compositions of the months
occurs during a four-year span except for six of the
seven types of leap-year February compositions. In other
words, by ignoring leap-year Februaries, four years of
data would be sufficient to guarantee that all of the
different month compositions occur. Let S6 be the ma-
trix of all of the different possible combinations of re-
gressors in (4) except for those corresponding to leap-
year Februaries. In other words, the rows of Sa are
obtained from the rows of T6 by removing the rows
derived from the presence of leap-year Februaries. The
eigenvalues of S^S6are reported in Table 3. Based on
this table, it follows that, as long as we have at least
four years of data, the matrix X^X6will be nonsingular
for 6(B) = 1 and 6(B) = (1 - B). On the other hand,
if 6(B) contains a factor (1 - B12) and the effect of
leap-year Februaries is ignored, part (b) of the lemma
in Section 2 indicates that the matrix X^X6 is singular.
The eigenvector associated with the 0 eigenvalue in both
of these cases is proportional to e = (1, 1, 1, 1, 1, 1,
1)', reflecting the fact that, after taking twelfth differ-
ences, the sum of any row of X6 is 0 when the influence
of leap-year Februaries is ignored.
Consider the situation in which the data span a period
of time longer than four years so that at least one leap-
year February occurs. When 6(B) = 1 - B'2 or (1 -
B)(1 - B12), it can be shown that XAX6is nonsingular.
This is because the 0 eigenvalue of S'Sb has eigenspace
{Ae : A E R}. If a row s' is added to the matrix S6 to
form a matrix S and if v is a nonzero 7 x 1 vector, then
s
v'S'Sv = v'[S, Si] v = v'SbS6v + (s;v)2. (5)
Table2. Eigenvaluesof T'T6for VariousValuesof 6(B)
1 (1 - B) (1 - B12) B)(1- B12)
1.84 9.81 2.00 4.00
1.84 9.81 5.83 36.94
2.86 11.11 5.83 36.94
2.86 11.11 13.64 45.53
9.30 28.00 13.64 45.56
9.30 70.08 28.53 195.53
2,814.00 70.08 28.53 195.53
Problemsin ModelingTime Series 433
Table3. Eigenvaluesof S'S, for VariousValuesof 6(B)
1 (1 - B) (1 - B'2) (1 - B)(1 - B'2)
.84 5.19 0.00 0.00
.84 5.19 3.83 25.57
1.86 5.83 3.83 25.57
1.86 5.83 11.64 30.08
8.30 20.00 11.64 30.08
8.30 55.98 26.53 154.35
1,973.00 55.98 26.53 154.35
Thus S'S is singular iff (5) is 0, which occurs iff v is in
the eigenspace of S^S6and s'v = 0. This will happen
iff the sum of the elements of the added row, s', equals
0. But it is easily verified (see Salinas 1983) that the
sum of any row of trading-day variables associated with
6(B) = (1 - B'2) or (1 - B)(1 - B12) and with leap-
year Februaries does not sum to 0. Thus, by applying
the second part of the lemma in Section 2, in most
practical situations (those with more than four years of
data) the matrix XX<, will be nonsingular.
The analysis of this section shows that, when we are
estimating a model of the form (4) in the case in which
the X,i are trading-day variables, the matrix X^X5 may
be ill-conditioned. When 6(B) contains a twelfth dif-
ference, Equation (4) is nearly overparameterized, since
the only reason that the full seven parameters are re-
quired is because of the influence of leap-year Febru-
aries, which occur infrequently. This indicates that the
characteristics of the correlation matrix of the param-
eter estimates in the example of Section 1 is a problem
that will occur more generally.
The preceding analysis suggests the potential for mul-
ticollinearity problems in the design matrix Xg. To more
fully understand the extent of these problems, we follow
the analysis of Belsley, Kuh, and Welsch (1980, chap.
3) to detect and assess multicollinearity. They developed
a number of measures to detect multicollinearity prob-
lems. In particular, they defined a set of condition in-
dexes, which are the largest singular value of X6 divided
by each of the singular values of X6. Based on some
practical experiences, they advised that weak linear de-
pendencies are associated with condition indexes of
about 5-10 and moderate to strong relationships are
associated with condition indexes of about 30-100. The
presence of one or more large condition indexes only
signals the potential of multicollinearity problems.
Belsley et al. (1980) also derived a decomposition of
the variance of the parameter estimates var(bi) into a
sum of components in which each component is asso-
ciated with exactly one of the singular values. They
argued that for a collinearity problem to exist there must
be an unusually high proportion of the variance of two
or more of the bi's concentrated in the components
associated with one small singular value. These consid-
erations led them to a diagnostic procedure for multi-
collinearity that requires both (a) a singular value with
a high condition index, which is associated with (b) a
434 Journalof Business & EconomicStatistics,July 1987

Table4. VarianceDecompositionProportionsand ConditionIndexes (data from1976-1985)

Variancedecompositionproportions
Condition
index var(b) var(b2) var(b3) var(b4) var(b5) var(b6) var(b7)

6(B)= 1
1.00
14.98 .01 .05 .04 - .03 .07 .02
15.26 .06 .01 .02 .07 .03 - .05
35.34 .13 .19 .07 .41 .01 .31 .14
36.20 .21 .06 .23 .02 .46 .06 .26
43.99 .58 .59 .25 .02 .02 .13 .29
45.78 .01 .10 .38 .48 .44 .44 .24
6(B) = (1 - B)
1.00 .01 .04 .03 - .03 .04 .01
1.01 .04 - .02 .05 .02 - .04
2.56 .03 .15 .16 .06 .28 .03 .35
2.75 - .06 .14 .41 .05 .27 .28
2.82 .40 .01 .10 .01 .49 .17 .14
3.01 .40 .51 .31 .05 .07 .08 -
3.25 .11 .23 .25 .43 .06 .40 .18
6(B) = (1 - B'2)
1.00 .02 .01 - - .02 .01
1.03 - - .01 .01 - .01 .02
1.53 - .02 - .04 .02 .01 .04
1.59 .02 - .04 .01 .03 .04
1.81 .08 .07 .01 - - .01 .02
1.97 - .01 .04 .06 .03 .05 .02
10.50 .88 .89 .89 .87 .90 .87 .90
6(B) = (1 - B)(1 - B12)
1.00 .01 - - .01 - -
1.03 - - .01 .01 - .01 .01
1.70 .01 - .01 .02 - .03 .04
1.82 - .01 .01 .01 .06 .02 -
1.91 .06 .05 - .01 - .01
2.10 - .01 .06 .03 .01 .02 .02
13.13 .91 .91 .91 .90 .92 .91 .92
NOTE: A dash indicatesa value less than .01.

highvariancedecompositionproportionfor two or more 3. In cases in whicha twelfthdifferenceis partof the

estimatedcoefficients.
In an attempt to determinethe extent of the multi-
collinearityproblemsassociatedwith modelingtime se-
ries affected by trading-dayvariation, the condition
indexes and associated variance-decompositionpro-
portionsfor the matrixX6 are reportedin Table 4. The
valueswere computedusingthe datafor the years1976-
1985;however,the generalcharacteristicsof anytypical
set of trading-dayvariablesare the same as those ex-
hibitedin Table 4. Based on these results,we have the
followingconclusions:
1. When modelinga time series affected by trading-
dayvariationwitha stationarynoisecomponent(6(B) =
1), the correspondingdesign matrixhas six moderate
to large condition indexes, and several of these have
two or more componentswith large variance-decom-
position proportions.Thus it appearsin this case as if
multicollinearityis a problem.
2. If S(B) = (1 - B) so that the first difference of
the time series affected by trading-dayvariationhas a
stationarynoise component, there does not appearto
be a problemwith multicollinearity.
factor requiredto make the noise componentstation-
ary, 6(B) = (1 - B12) or (1 - B)(1 - B12), there is
one moderatelylarge condition index, and associated
with this conditionindex there are very large variance-
decompositionproportionsfor all of the components.
Thisindicatesthat a multicollinearityproblemexistsfor
both of these cases.
4. REPARAMETERIZATIONS
It has been pointedout by severalauthorsthat in the
presence of multicollinearityit is still possible to esti-
mate preciselysome linearcombinationsof the param-
eters (see, e.g., Malinvand1970, pp. 216-221; Theil
1971,pp. 153-154). Becauseof this fact, it is sometimes
possibleto alleviatea multicollinearityproblemby a re-
parameterizationof the model being estimated.Belsley
et al. (1980, p. 177) discussedthe possibilityof repa-
rameterizationand pointedout that the appropriatere-
parameterizationdepends on the design matrix,which
in most cases is determinedby chanceoutcomesof the
data. In the case of modeling time series affected by
trading-dayfactors, however, the design matrixX6 is,
 Salinas and Hillmer:Multicollinearity
Problemsin ModelingTime Series 435

Table5. VarianceDecompositionProportionsand ConditionIndexes-Reparameterization

(data from 1976-1985)

Variancedecompositionproportions
Condition
index var(b,) var(b) var(b3) var(b4) var(bs) var(b6) var(b7)

6(B)= 1
1.00 - - -- -1.00
21.64 - .01 .02 .02 .01 -
39.73 .03 .06 .02 .01 .06 .04
72.51 .24 .05 .10 .12 .04 .20
94.37 .19 - .34 .23 .09 .42
107.23 .38 .45 .03 .20 .39 .14
121.04 .16 .42 .49 .42 .40 .19
6(B) = (1 - B'2)
1.00 .01 .02 .03 .03 .02 .01
2.09 .06 .12 .06 .02 .14 .11 -
2.70 .27 .03 .07 .24 .01 .26
3.11 .21 - .37 .11 .12 .35
3.37 .32 .39 .01 .25 .31 .06
3.97 .13 .42 .42 .31 .36 .19
8.11 - .02 .04 .03 .04 .02 1.00
6(B) = (1 - B)(1 - B'2)
1.00 .01 .01 .03 .03 .02 .01
2.04 .05 .10 .05 .02 .14 .10
2.79 .32 - .03 .14 .01 .36 -
3.47 .05 .20 .33 .04 .48 .21 -
3.63 .28 .07 .23 .67 .11 .05
4.16 .30 .60 .29 .09 .23 .26
9.91 -.01 .04 .02 .02 .01 1.00

NOTE: A dash indicates a value less than .01.

aside from the differencing,determinedlargelyby the
calendar,and consequentlyit is relativelystable across
differentsets of data. This suggests that the reparam-
eterizationpossibilityis feasible in this situation.
It is interestingthat a numberof authorswho have
been involvedwith modelingtime series influencedby
trading-dayfactors have used a common parameteri-
zation. For example, Bell and Hillmer (1983) used the
parameterization
7 index is a single component with a high variancede-
TD, = yiVti,
i=l
(1 - B)(1 - B12). Based on the results reported in
Table 5, we make the followingobservations:
1. If the noise componentis stationary,there are six
condition indexes that are large, so that the reparam-
eterizationdoes not alleviate the multicollinearity.
2. Whenthe noisemodelhasdifferencing terms6(B) =
(1 - B'2) or (1 - B)(1 - B12), then the design matrix
associated with the reparameterizedmodel has one
moderate-sizedconditionindex, and associatedwiththat
(6) compositionproportion.

where Vi = X,i - Xt7, the number of a given day of
the week in month t minus the numberof Sundaysin
month t, and Vt7 = 7_=1Xt, the number of days in
month t. Young (1965) used a multiplicativeform of
this parameterization,Clevelandand Devlin (1982)used
the form (6) subject to the constraintthat 7=, y, = 0,
and Cleveland and Grupe (1983) used a similarrepa-
rameterization.
In an attempt to understandthe nature of the mul-
ticollinearityproblems associatedwith the parameter-
izationin (6), we createdthe matrixV?, whose ith col-
umn containsthe elements 3(B)V,i,and performedthe
Belsley et al. (1980) analysis on the matrix V6. The
condition indexes and associatedvariance-decomposi-
tion proportionsbased on data for the years 1976-1985
are reported in Table 5 for 6(B) = 1, (1 - B12), and
Thus, accordingto the criteriaset up by Belsley et al.
(1980), there is no evidence of a serious multicollin-
earity problem in the reparameterizedmodel. There-
fore, one virtue of the parameterizationin (6) is that
inferenceaboutindividualparameterscan be more eas-
ily made. This gives one reason to explain why this
particularreparameterizationmay be popular.
5. CONCLUSIONS
We have analyzedthe extent of the multicollinearity
problemsassociatedwith time series affected by trad-
ing-dayfactors. Based on our results, there are multi-
collinearityproblemsinherentwhen the noise compo-
nent is stationaryor requires a twelfth difference to
make it stationary. One way to greatly alleviate the
multicollinearityproblemswhen the noise component
436 Journalof Business & EconomicStatistics,July 1987
has a factor (1 - B12) is to use a popular reparame-
terization.
ACKNOWLEDGMENTS
The comments of two referees played an important
role in improving the article. This research is based on
work supported by National Science Foundation Grant
SES-8219336.
[ReceivedAugust1986. RevisedNovember1986.]
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