follow an AR(1) model with parameter r and so we apply the Prais-Winsten method. If the errors do not follow an AR(1) model–for example, suppose they follow an AR(2) model, or an MA(1) model–why will the usual Prais-Winsten standard errors be incorrect?

(ii) Can you think of a way to use the Newey-West procedure, in conjunction with Prais-Winsten estimation, to obtain valid standard errors? Be very specific about the steps you would follow.

[Hint: It may help to study equation (12.32) and note that, if 5ut 6 does not follow an AR(1)

process, et generally should be replaced by ut 2 rut21, where r is the probability limit of the estimator r^. Now, is the error 5ut 2 rut216 serially uncorrelated in general? What can you do if it is not?]

(iii) Explain why your answer to part (ii) should not change if we drop Assumption TS.4.