Improved local polynomial estimation in time series regression

We propose a modification of local polynomial estimation which improves the efficiency of the conventional method when the observation errors are correlated. The procedure is based on a pre-transformation of the data as a generalization of the pre-whitening procedure introduced by Xiao et al. [(2003), More Efficient Local Polynomial Estimation in Nonparametric Regression with Autocorrelated Errors', Journal of the American Statistical Association, 98, 980-992]. While these authors assumed a linear process representation for the error process, we avoid any structural assumption. We further allow the regressors and the errors to be dependent. More importantly, we show that the inclusion of both leading and lagged variables in the approximation of the error terms outperforms the best approximation based on lagged variables only. Establishing its asymptotic distribution, we show that the proposed estimator is more efficient than the standard local polynomial estimator. As a by-product we prove a suitable version of a central limit theorem which allows us to improve the asymptotic normality result for local polynomial estimators by Masry and Fan [(1997), Local Polynomial Estimation of Regression Functions for Mixing Processes', Scandinavian Journal of Statistics, 24, 165-179]. A simulation study confirms the efficiency of our estimator on finite samples. An application to climate data also shows that our new method leads to an estimator with decreased variability.