Stay Ahead, Stay ONMINE

Linear Regression in Time Series: Sources of Spurious Regression

1. Introduction It’s pretty clear that most of our work will be automated by AI in the future. This will be possible because many researchers and professionals are working hard to make their work available online. These contributions not only help us understand fundamental concepts but also refine AI models, ultimately freeing up time to focus on other activities. However, there is one concept that remains misunderstood, even among experts. It is spurious regression in time series analysis. This issue arises when regression models suggest strong relationships between variables, even when none exist. It is typically observed in time series regression equations that seem to have a high degree of fit — as indicated by a high R² (coefficient of multiple correlation) — but with an extremely low Durbin-Watson statistic (d), signaling strong autocorrelation in the error terms. What is particularly surprising is that almost all econometric textbooks warn about the danger of autocorrelated errors, yet this issue persists in many published papers. Granger and Newbold (1974) identified several examples. For instance, they found published equations with R² = 0.997 and the Durbin-Watson statistic (d) equal to 0.53. The most extreme found is an equation with R² = 0.999 and d = 0.093. It is especially problematic in economics and finance, where many key variables exhibit autocorrelation or serial correlation between adjacent values, particularly if the sampling interval is small, such as a week or a month, leading to misleading conclusions if not handled correctly. For example, today’s GDP is strongly correlated with the GDP of the previous quarter. Our post provides a detailed explanation of the results from Granger and Newbold (1974) and Python simulation (see section 7) replicating the key results presented in their article. Whether you’re an economist, data scientist, or analyst working with time series data, understanding this issue is crucial to ensuring your models produce meaningful results. To walk you through this paper, the next section will introduce the random walk and the ARIMA(0,1,1) process. In section 3, we will explain how Granger and Newbold (1974) describe the emergence of nonsense regressions, with examples illustrated in section 4. Finally, we’ll show how to avoid spurious regressions when working with time series data. 2. Simple presentation of a Random Walk and ARIMA(0,1,1) Process 2.1 Random Walk Let 𝐗ₜ be a time series. We say that 𝐗ₜ follows a random walk if its representation is given by: 𝐗ₜ = 𝐗ₜ₋₁ + 𝜖ₜ. (1) Where 𝜖ₜ is a white noise. It can be written as a sum of white noise, a useful form for simulation. It is a non-stationary time series because its variance depends on the time t. 2.2 ARIMA(0,1,1) Process The ARIMA(0,1,1) process is given by: 𝐗ₜ = 𝐗ₜ₋₁ + 𝜖ₜ − 𝜃 𝜖ₜ₋₁. (2) where 𝜖ₜ is a white noise. The ARIMA(0,1,1) process is non-stationary. It can be written as a sum of an independent random walk and white noise: 𝐗ₜ = 𝐗₀ + random walk + white noise. (3) This form is useful for simulation. Those non-stationary series are often employed as benchmarks against which the forecasting performance of other models is judged. 3. Random walk can lead to Nonsense Regression First, let’s recall the Linear Regression model. The linear regression model is given by: 𝐘 = 𝐗𝛽 + 𝜖. (4) Where 𝐘 is a T × 1 vector of the dependent variable, 𝛽 is a K × 1 vector of the coefficients, 𝐗 is a T × K matrix of the independent variables containing a column of ones and (K−1) columns with T observations on each of the (K−1) independent variables, which are stochastic but distributed independently of the T × 1 vector of the errors 𝜖. It is generally assumed that: 𝐄(𝜖) = 0, (5) and 𝐄(𝜖𝜖′) = 𝜎²𝐈. (6) where 𝐈 is the identity matrix. A test of the contribution of independent variables to the explanation of the dependent variable is the F-test. The null hypothesis of the test is given by: 𝐇₀: 𝛽₁ = 𝛽₂ = ⋯ = 𝛽ₖ₋₁ = 0, (7) And the statistic of the test is given by: 𝐅 = (𝐑² / (𝐊−1)) / ((1−𝐑²) / (𝐓−𝐊)). (8) where 𝐑² is the coefficient of determination. If we want to construct the statistic of the test, let’s assume that the null hypothesis is true, and one tries to fit a regression of the form (Equation 4) to the levels of an economic time series. Suppose next that these series are not stationary or are highly autocorrelated. In such a situation, the test procedure is invalid since 𝐅 in (Equation 8) is not distributed as an F-distribution under the null hypothesis (Equation 7). In fact, under the null hypothesis, the errors or residuals from (Equation 4) are given by: 𝜖ₜ = 𝐘ₜ − 𝐗𝛽₀ ; t = 1, 2, …, T. (9) And will have the same autocorrelation structure as the original series 𝐘. Some idea of the distribution problem can arise in the situation when: 𝐘ₜ = 𝛽₀ + 𝐗ₜ𝛽₁ + 𝜖ₜ. (10) Where 𝐘ₜ and 𝐗ₜ follow independent first-order autoregressive processes: 𝐘ₜ = 𝜌 𝐘ₜ₋₁ + 𝜂ₜ, and 𝐗ₜ = 𝜌* 𝐗ₜ₋₁ + 𝜈ₜ. (11) Where 𝜂ₜ and 𝜈ₜ are white noise. We know that in this case, 𝐑² is the square of the correlation between 𝐘ₜ and 𝐗ₜ. They use Kendall’s result from the article Knowles (1954), which expresses the variance of 𝐑: 𝐕𝐚𝐫(𝐑) = (1/T)* (1 + 𝜌𝜌*) / (1 − 𝜌𝜌*). (12) Since 𝐑 is constrained to lie between -1 and 1, if its variance is greater than 1/3, the distribution of 𝐑 cannot have a mode at 0. This implies that 𝜌𝜌* > (T−1) / (T+1). Thus, for example, if T = 20 and 𝜌 = 𝜌*, a distribution that is not unimodal at 0 will be obtained if 𝜌 > 0.86, and if 𝜌 = 0.9, 𝐕𝐚𝐫(𝐑) = 0.47. So the 𝐄(𝐑²) will be close to 0.47. It has been shown that when 𝜌 is close to 1, 𝐑² can be very high, suggesting a strong relationship between 𝐘ₜ and 𝐗ₜ. However, in reality, the two series are completely independent. When 𝜌 is near 1, both series behave like random walks or near-random walks. On top of that, both series are highly autocorrelated, which causes the residuals from the regression to also be strongly autocorrelated. As a result, the Durbin-Watson statistic 𝐝 will be very low. This is why a high 𝐑² in this context should never be taken as evidence of a true relationship between the two series. To explore the possibility of obtaining a spurious regression when regressing two independent random walks, a series of simulations proposed by Granger and Newbold (1974) will be conducted in the next section. 4. Simulation results using Python. In this section, we will show using simulations that using the regression model with independent random walks bias the estimation of the coefficients and the hypothesis tests of the coefficients are invalid. The Python code that will produce the results of the simulation will be presented in section 6. A regression equation proposed by Granger and Newbold (1974) is given by: 𝐘ₜ = 𝛽₀ + 𝐗ₜ𝛽₁ + 𝜖ₜ Where 𝐘ₜ and 𝐗ₜ were generated as independent random walks, each of length 50. The values 𝐒 = |𝛽̂₁| / √(𝐒𝐄̂(𝛽̂₁)), representing the statistic for testing the significance of 𝛽₁, for 100 simulations will be reported in the table below. Table 1: Regressing two independent random walks The null hypothesis of no relationship between 𝐘ₜ and 𝐗ₜ is rejected at the 5% level if 𝐒 > 2. This table shows that the null hypothesis (𝛽 = 0) is wrongly rejected in about a quarter (71 times) of all cases. This is awkward because the two variables are independent random walks, meaning there’s no actual relationship. Let’s break down why this happens. If 𝛽̂₁ / 𝐒𝐄̂ follows a 𝐍(0,1), the expected value of 𝐒, its absolute value, should be √2 / π ≈ 0.8 (√2/π is the mean of the absolute value of a standard normal distribution). However, the simulation results show an average of 4.59, meaning the estimated 𝐒 is underestimated by a factor of: 4.59 / 0.8 = 5.7 In classical statistics, we usually use a t-test threshold of around 2 to check the significance of a coefficient. However, these results show that, in this case, you would need to use a threshold of 11.4 to properly test for significance: 2 × (4.59 / 0.8) = 11.4 Interpretation: We’ve just shown that including variables that don’t belong in the model — especially random walks — can lead to completely invalid significance tests for the coefficients. To make their simulations even clearer, Granger and Newbold (1974) ran a series of regressions using variables that follow either a random walk or an ARIMA(0,1,1) process. Here is how they set up their simulations: They regressed a dependent series 𝐘ₜ on m series 𝐗ⱼ,ₜ (with j = 1, 2, …, m), varying m from 1 to 5. The dependent series 𝐘ₜ and the independent series 𝐗ⱼ,ₜ follow the same types of processes, and they tested four cases: Case 1 (Levels): 𝐘ₜ and 𝐗ⱼ,ₜ follow random walks. Case 2 (Differences): They use the first differences of the random walks, which are stationary. Case 3 (Levels): 𝐘ₜ and 𝐗ⱼ,ₜ follow ARIMA(0,1,1). Case 4 (Differences): They use the first differences of the previous ARIMA(0,1,1) processes, which are stationary. Each series has a length of 50 observations, and they ran 100 simulations for each case. All error terms are distributed as 𝐍(0,1), and the ARIMA(0,1,1) series are derived as the sum of the random walk and independent white noise. The simulation results, based on 100 replications with series of length 50, are summarized in the next table. Table 2: Regressions of a series on m independent ‘explanatory’ series. Interpretation of the results : It is seen that the probability of not rejecting the null hypothesis of no relationship between 𝐘ₜ and 𝐗ⱼ,ₜ becomes very small when m ≥ 3 when regressions are made with random walk series (rw-levels). The 𝐑² and the mean Durbin-Watson increase. Similar results are obtained when the regressions are made with ARIMA(0,1,1) series (arima-levels). When white noise series (rw-diffs) are used, classical regression analysis is valid since the error series will be white noise and least squares will be efficient. However, when the regressions are made with the differences of ARIMA(0,1,1) series (arima-diffs) or first-order moving average series MA(1) process, the null hypothesis is rejected, on average: (10 + 16 + 5 + 6 + 6) / 5 = 8.6 which is greater than 5% of the time. If your variables are random walks or close to them, and you include unnecessary variables in your regression, you will often get fallacious results. High 𝐑² and low Durbin-Watson values do not confirm a true relationship but instead indicate a likely spurious one. 5. How to avoid spurious regression in time series It’s really hard to come up with a complete list of ways to avoid spurious regressions. However, there are a few good practices you can follow to minimize the risk as much as possible. If one performs a regression analysis with time series data and finds that the residuals are strongly autocorrelated, there is a serious problem when it comes to interpreting the coefficients of the equation. To check for autocorrelation in the residuals, one can use the Durbin-Watson test or the Portmanteau test. Based on the study above, we can conclude that if a regression analysis performed with economical variables produces strongly autocorrelated residuals, meaning a low Durbin-Watson statistic, then the results of the analysis are likely to be spurious, whatever the value of the coefficient of determination R² observed. In such cases, it is important to understand where the mis-specification comes from. According to the literature, misspecification usually falls into three categories : (i) the omission of a relevant variable, (ii) the inclusion of an irrelevant variable, or (iii) autocorrelation of the errors. Most of the time, mis-specification comes from a mix of these three sources. To avoid spurious regression in a time series, several recommendations can be made: The first recommendation is to select the right macroeconomic variables that are likely to explain the dependent variable. This can be done by reviewing the literature or consulting experts in the field. The second recommendation is to stationarize the series by taking first differences. In most cases, the first differences of macroeconomic variables are stationary and still easy to interpret. For macroeconomic data, it’s strongly recommended to differentiate the series once to reduce the autocorrelation of the residuals, especially when the sample size is small. There is indeed sometimes strong serial correlation observed in these variables. A simple calculation shows that the first differences will almost always have much smaller serial correlations than the original series. The third recommendation is to use the Box-Jenkins methodology to model each macroeconomic variable individually and then search for relationships between the series by relating the residuals from each individual model. The idea here is that the Box-Jenkins process extracts the explained part of the series, leaving the residuals, which contain only what can’t be explained by the series’ own past behavior. This makes it easier to check whether these unexplained parts (residuals) are related across variables. 6. Conclusion Many econometrics textbooks warn about specification errors in regression models, but the problem still shows up in many published papers. Granger and Newbold (1974) highlighted the risk of spurious regressions, where you get a high paired with very low Durbin-Watson statistics. Using Python simulations, we showed some of the main causes of these spurious regressions, especially including variables that don’t belong in the model and are highly autocorrelated. We also demonstrated how these issues can completely distort hypothesis tests on the coefficients. Hopefully, this post will help reduce the risk of spurious regressions in future econometric analyses. 7. Appendice: Python code for simulation. #####################################################Simulation Code for table 1 ##################################################### import numpy as np import pandas as pd import statsmodels.api as sm import matplotlib.pyplot as plt np.random.seed(123) M = 100 n = 50 S = np.zeros(M) for i in range(M): #————————————————————— # Generate the data #————————————————————— espilon_y = np.random.normal(0, 1, n) espilon_x = np.random.normal(0, 1, n) Y = np.cumsum(espilon_y) X = np.cumsum(espilon_x) #————————————————————— # Fit the model #————————————————————— X = sm.add_constant(X) model = sm.OLS(Y, X).fit() #————————————————————— # Compute the statistic #—————————————————— S[i] = np.abs(model.params[1])/model.bse[1] #—————————————————— # Maximum value of S #—————————————————— S_max = int(np.ceil(max(S))) #—————————————————— # Create bins #—————————————————— bins = np.arange(0, S_max + 2, 1) #—————————————————— # Compute the histogram #—————————————————— frequency, bin_edges = np.histogram(S, bins=bins) #—————————————————— # Create a dataframe #—————————————————— df = pd.DataFrame({ “S Interval”: [f”{int(bin_edges[i])}-{int(bin_edges[i+1])}” for i in range(len(bin_edges)-1)], “Frequency”: frequency }) print(df) print(np.mean(S)) #####################################################Simulation Code for table 2 ##################################################### import numpy as np import pandas as pd import statsmodels.api as sm from statsmodels.stats.stattools import durbin_watson from tabulate import tabulate np.random.seed(1) # Pour rendre les résultats reproductibles #—————————————————— # Definition of functions #—————————————————— def generate_random_walk(T): “”” Génère une série de longueur T suivant un random walk : Y_t = Y_{t-1} + e_t, où e_t ~ N(0,1). “”” e = np.random.normal(0, 1, size=T) return np.cumsum(e) def generate_arima_0_1_1(T): “”” Génère un ARIMA(0,1,1) selon la méthode de Granger & Newbold : la série est obtenue en additionnant une marche aléatoire et un bruit blanc indépendant. “”” rw = generate_random_walk(T) wn = np.random.normal(0, 1, size=T) return rw + wn def difference(series): “”” Calcule la différence première d’une série unidimensionnelle. Retourne une série de longueur T-1. “”” return np.diff(series) #—————————————————— # Paramètres #—————————————————— T = 50 # longueur de chaque série n_sims = 100 # nombre de simulations Monte Carlo alpha = 0.05 # seuil de significativité #—————————————————— # Definition of function for simulation #—————————————————— def run_simulation_case(case_name, m_values=[1,2,3,4,5]): “”” case_name : un identifiant pour le type de génération : – ‘rw-levels’ : random walk (levels) – ‘rw-diffs’ : differences of RW (white noise) – ‘arima-levels’ : ARIMA(0,1,1) en niveaux – ‘arima-diffs’ : différences d’un ARIMA(0,1,1) = > MA(1) m_values : liste du nombre de régresseurs. Retourne un DataFrame avec pour chaque m : – % de rejets de H0 – Durbin-Watson moyen – R^2_adj moyen – % de R^2 > 0.1 “”” results = [] for m in m_values: count_reject = 0 dw_list = [] r2_adjusted_list = [] for _ in range(n_sims): #————————————– # 1) Generation of independents de Y_t and X_{j,t}. #—————————————- if case_name == ‘rw-levels’: Y = generate_random_walk(T) Xs = [generate_random_walk(T) for __ in range(m)] elif case_name == ‘rw-diffs’: # Y et X sont les différences d’un RW, i.e. ~ white noise Y_rw = generate_random_walk(T) Y = difference(Y_rw) Xs = [] for __ in range(m): X_rw = generate_random_walk(T) Xs.append(difference(X_rw)) # NB : maintenant Y et Xs ont longueur T-1 # = > ajuster T_effectif = T-1 # = > on prendra T_effectif points pour la régression elif case_name == ‘arima-levels’: Y = generate_arima_0_1_1(T) Xs = [generate_arima_0_1_1(T) for __ in range(m)] elif case_name == ‘arima-diffs’: # Différences d’un ARIMA(0,1,1) = > MA(1) Y_arima = generate_arima_0_1_1(T) Y = difference(Y_arima) Xs = [] for __ in range(m): X_arima = generate_arima_0_1_1(T) Xs.append(difference(X_arima)) # 2) Prépare les données pour la régression # Selon le cas, la longueur est T ou T-1 if case_name in [‘rw-levels’,’arima-levels’]: Y_reg = Y X_reg = np.column_stack(Xs) if m >0 else np.array([]) else: # dans les cas de différences, la longueur est T-1 Y_reg = Y X_reg = np.column_stack(Xs) if m >0 else np.array([]) # 3) Régression OLS X_with_const = sm.add_constant(X_reg) # Ajout de l’ordonnée à l’origine model = sm.OLS(Y_reg, X_with_const).fit() # 4) Test global F : H0 : tous les beta_j = 0 # On regarde si p-value < alpha if model.f_pvalue is not None and model.f_pvalue 0.7) results.append({ ‘m’: m, ‘Reject %’: reject_percent, ‘Mean DW’: dw_mean, ‘Mean R^2’: r2_mean, ‘% R^2_adj >0.7’: r2_above_0_7_percent }) return pd.DataFrame(results) #—————————————————— # Application of the simulation #—————————————————— cases = [‘rw-levels’, ‘rw-diffs’, ‘arima-levels’, ‘arima-diffs’] all_results = {} for c in cases: df_res = run_simulation_case(c, m_values=[1,2,3,4,5]) all_results[c] = df_res #—————————————————— # Store data in table #—————————————————— for case, df_res in all_results.items(): print(f”nn{case}”) print(tabulate(df_res, headers=’keys’, tablefmt=’fancy_grid’)) References Granger, Clive WJ, and Paul Newbold. 1974. “Spurious Regressions in Econometrics.” Journal of Econometrics 2 (2): 111–20. Knowles, EAG. 1954. “Exercises in Theoretical Statistics.” Oxford University Press.

1. Introduction

It’s pretty clear that most of our work will be automated by AI in the future. This will be possible because many researchers and professionals are working hard to make their work available online. These contributions not only help us understand fundamental concepts but also refine AI models, ultimately freeing up time to focus on other activities.

However, there is one concept that remains misunderstood, even among experts. It is spurious regression in time series analysis. This issue arises when regression models suggest strong relationships between variables, even when none exist. It is typically observed in time series regression equations that seem to have a high degree of fit — as indicated by a high R² (coefficient of multiple correlation) — but with an extremely low Durbin-Watson statistic (d), signaling strong autocorrelation in the error terms.

What is particularly surprising is that almost all econometric textbooks warn about the danger of autocorrelated errors, yet this issue persists in many published papers. Granger and Newbold (1974) identified several examples. For instance, they found published equations with R² = 0.997 and the Durbin-Watson statistic (d) equal to 0.53. The most extreme found is an equation with R² = 0.999 and d = 0.093.

It is especially problematic in economics and finance, where many key variables exhibit autocorrelation or serial correlation between adjacent values, particularly if the sampling interval is small, such as a week or a month, leading to misleading conclusions if not handled correctly. For example, today’s GDP is strongly correlated with the GDP of the previous quarter. Our post provides a detailed explanation of the results from Granger and Newbold (1974) and Python simulation (see section 7) replicating the key results presented in their article.

Whether you’re an economist, data scientist, or analyst working with time series data, understanding this issue is crucial to ensuring your models produce meaningful results.

To walk you through this paper, the next section will introduce the random walk and the ARIMA(0,1,1) process. In section 3, we will explain how Granger and Newbold (1974) describe the emergence of nonsense regressions, with examples illustrated in section 4. Finally, we’ll show how to avoid spurious regressions when working with time series data.

2. Simple presentation of a Random Walk and ARIMA(0,1,1) Process

2.1 Random Walk

Let 𝐗ₜ be a time series. We say that 𝐗ₜ follows a random walk if its representation is given by:

𝐗ₜ = 𝐗ₜ₋₁ + 𝜖ₜ. (1)

Where 𝜖ₜ is a white noise. It can be written as a sum of white noise, a useful form for simulation. It is a non-stationary time series because its variance depends on the time t.

2.2 ARIMA(0,1,1) Process

The ARIMA(0,1,1) process is given by:

𝐗ₜ = 𝐗ₜ₋₁ + 𝜖ₜ − 𝜃 𝜖ₜ₋₁. (2)

where 𝜖ₜ is a white noise. The ARIMA(0,1,1) process is non-stationary. It can be written as a sum of an independent random walk and white noise:

𝐗ₜ = 𝐗₀ + random walk + white noise. (3) This form is useful for simulation.

Those non-stationary series are often employed as benchmarks against which the forecasting performance of other models is judged.

3. Random walk can lead to Nonsense Regression

First, let’s recall the Linear Regression model. The linear regression model is given by:

𝐘 = 𝐗𝛽 + 𝜖. (4)

Where 𝐘 is a T × 1 vector of the dependent variable, 𝛽 is a K × 1 vector of the coefficients, 𝐗 is a T × K matrix of the independent variables containing a column of ones and (K−1) columns with T observations on each of the (K−1) independent variables, which are stochastic but distributed independently of the T × 1 vector of the errors 𝜖. It is generally assumed that:

𝐄(𝜖) = 0, (5)

and

𝐄(𝜖𝜖′) = 𝜎²𝐈. (6)

where 𝐈 is the identity matrix.

A test of the contribution of independent variables to the explanation of the dependent variable is the F-test. The null hypothesis of the test is given by:

𝐇₀: 𝛽₁ = 𝛽₂ = ⋯ = 𝛽ₖ₋₁ = 0, (7)

And the statistic of the test is given by:

𝐅 = (𝐑² / (𝐊−1)) / ((1−𝐑²) / (𝐓−𝐊)). (8)

where 𝐑² is the coefficient of determination.

If we want to construct the statistic of the test, let’s assume that the null hypothesis is true, and one tries to fit a regression of the form (Equation 4) to the levels of an economic time series. Suppose next that these series are not stationary or are highly autocorrelated. In such a situation, the test procedure is invalid since 𝐅 in (Equation 8) is not distributed as an F-distribution under the null hypothesis (Equation 7). In fact, under the null hypothesis, the errors or residuals from (Equation 4) are given by:

𝜖ₜ = 𝐘ₜ − 𝐗𝛽₀ ; t = 1, 2, …, T. (9)

And will have the same autocorrelation structure as the original series 𝐘.

Some idea of the distribution problem can arise in the situation when:

𝐘ₜ = 𝛽₀ + 𝐗ₜ𝛽₁ + 𝜖ₜ. (10)

Where 𝐘ₜ and 𝐗ₜ follow independent first-order autoregressive processes:

𝐘ₜ = 𝜌 𝐘ₜ₋₁ + 𝜂ₜ, and 𝐗ₜ = 𝜌* 𝐗ₜ₋₁ + 𝜈ₜ. (11)

Where 𝜂ₜ and 𝜈ₜ are white noise.

We know that in this case, 𝐑² is the square of the correlation between 𝐘ₜ and 𝐗ₜ. They use Kendall’s result from the article Knowles (1954), which expresses the variance of 𝐑:

𝐕𝐚𝐫(𝐑) = (1/T)* (1 + 𝜌𝜌*) / (1 − 𝜌𝜌*). (12)

Since 𝐑 is constrained to lie between -1 and 1, if its variance is greater than 1/3, the distribution of 𝐑 cannot have a mode at 0. This implies that 𝜌𝜌* > (T−1) / (T+1).

Thus, for example, if T = 20 and 𝜌 = 𝜌*, a distribution that is not unimodal at 0 will be obtained if 𝜌 > 0.86, and if 𝜌 = 0.9, 𝐕𝐚𝐫(𝐑) = 0.47. So the 𝐄(𝐑²) will be close to 0.47.

It has been shown that when 𝜌 is close to 1, 𝐑² can be very high, suggesting a strong relationship between 𝐘ₜ and 𝐗ₜ. However, in reality, the two series are completely independent. When 𝜌 is near 1, both series behave like random walks or near-random walks. On top of that, both series are highly autocorrelated, which causes the residuals from the regression to also be strongly autocorrelated. As a result, the Durbin-Watson statistic 𝐝 will be very low.

This is why a high 𝐑² in this context should never be taken as evidence of a true relationship between the two series.

To explore the possibility of obtaining a spurious regression when regressing two independent random walks, a series of simulations proposed by Granger and Newbold (1974) will be conducted in the next section.

4. Simulation results using Python.

In this section, we will show using simulations that using the regression model with independent random walks bias the estimation of the coefficients and the hypothesis tests of the coefficients are invalid. The Python code that will produce the results of the simulation will be presented in section 6.

A regression equation proposed by Granger and Newbold (1974) is given by:

𝐘ₜ = 𝛽₀ + 𝐗ₜ𝛽₁ + 𝜖ₜ

Where 𝐘ₜ and 𝐗ₜ were generated as independent random walks, each of length 50. The values 𝐒 = |𝛽̂₁| / √(𝐒𝐄̂(𝛽̂₁)), representing the statistic for testing the significance of 𝛽₁, for 100 simulations will be reported in the table below.

Table 1: Regressing two independent random walks

The null hypothesis of no relationship between 𝐘ₜ and 𝐗ₜ is rejected at the 5% level if 𝐒 > 2. This table shows that the null hypothesis (𝛽 = 0) is wrongly rejected in about a quarter (71 times) of all cases. This is awkward because the two variables are independent random walks, meaning there’s no actual relationship. Let’s break down why this happens.

If 𝛽̂₁ / 𝐒𝐄̂ follows a 𝐍(0,1), the expected value of 𝐒, its absolute value, should be √2 / π ≈ 0.8 (√2/π is the mean of the absolute value of a standard normal distribution). However, the simulation results show an average of 4.59, meaning the estimated 𝐒 is underestimated by a factor of:

4.59 / 0.8 = 5.7

In classical statistics, we usually use a t-test threshold of around 2 to check the significance of a coefficient. However, these results show that, in this case, you would need to use a threshold of 11.4 to properly test for significance:

2 × (4.59 / 0.8) = 11.4

Interpretation: We’ve just shown that including variables that don’t belong in the model — especially random walks — can lead to completely invalid significance tests for the coefficients.

To make their simulations even clearer, Granger and Newbold (1974) ran a series of regressions using variables that follow either a random walk or an ARIMA(0,1,1) process.

Here is how they set up their simulations:

They regressed a dependent series 𝐘ₜ on m series 𝐗ⱼ,ₜ (with j = 1, 2, …, m), varying m from 1 to 5. The dependent series 𝐘ₜ and the independent series 𝐗ⱼ,ₜ follow the same types of processes, and they tested four cases:

  • Case 1 (Levels): 𝐘ₜ and 𝐗ⱼ,ₜ follow random walks.
  • Case 2 (Differences): They use the first differences of the random walks, which are stationary.
  • Case 3 (Levels): 𝐘ₜ and 𝐗ⱼ,ₜ follow ARIMA(0,1,1).
  • Case 4 (Differences): They use the first differences of the previous ARIMA(0,1,1) processes, which are stationary.

Each series has a length of 50 observations, and they ran 100 simulations for each case.

All error terms are distributed as 𝐍(0,1), and the ARIMA(0,1,1) series are derived as the sum of the random walk and independent white noise. The simulation results, based on 100 replications with series of length 50, are summarized in the next table.

Table 2: Regressions of a series on m independent ‘explanatory’ series.

Interpretation of the results :

  • It is seen that the probability of not rejecting the null hypothesis of no relationship between 𝐘ₜ and 𝐗ⱼ,ₜ becomes very small when m ≥ 3 when regressions are made with random walk series (rw-levels). The 𝐑² and the mean Durbin-Watson increase. Similar results are obtained when the regressions are made with ARIMA(0,1,1) series (arima-levels).
  • When white noise series (rw-diffs) are used, classical regression analysis is valid since the error series will be white noise and least squares will be efficient.
  • However, when the regressions are made with the differences of ARIMA(0,1,1) series (arima-diffs) or first-order moving average series MA(1) process, the null hypothesis is rejected, on average:

(10 + 16 + 5 + 6 + 6) / 5 = 8.6

which is greater than 5% of the time.

If your variables are random walks or close to them, and you include unnecessary variables in your regression, you will often get fallacious results. High 𝐑² and low Durbin-Watson values do not confirm a true relationship but instead indicate a likely spurious one.

5. How to avoid spurious regression in time series

It’s really hard to come up with a complete list of ways to avoid spurious regressions. However, there are a few good practices you can follow to minimize the risk as much as possible.

If one performs a regression analysis with time series data and finds that the residuals are strongly autocorrelated, there is a serious problem when it comes to interpreting the coefficients of the equation. To check for autocorrelation in the residuals, one can use the Durbin-Watson test or the Portmanteau test.

Based on the study above, we can conclude that if a regression analysis performed with economical variables produces strongly autocorrelated residuals, meaning a low Durbin-Watson statistic, then the results of the analysis are likely to be spurious, whatever the value of the coefficient of determination R² observed.

In such cases, it is important to understand where the mis-specification comes from. According to the literature, misspecification usually falls into three categories : (i) the omission of a relevant variable, (ii) the inclusion of an irrelevant variable, or (iii) autocorrelation of the errors. Most of the time, mis-specification comes from a mix of these three sources.

To avoid spurious regression in a time series, several recommendations can be made:

  • The first recommendation is to select the right macroeconomic variables that are likely to explain the dependent variable. This can be done by reviewing the literature or consulting experts in the field.
  • The second recommendation is to stationarize the series by taking first differences. In most cases, the first differences of macroeconomic variables are stationary and still easy to interpret. For macroeconomic data, it’s strongly recommended to differentiate the series once to reduce the autocorrelation of the residuals, especially when the sample size is small. There is indeed sometimes strong serial correlation observed in these variables. A simple calculation shows that the first differences will almost always have much smaller serial correlations than the original series.
  • The third recommendation is to use the Box-Jenkins methodology to model each macroeconomic variable individually and then search for relationships between the series by relating the residuals from each individual model. The idea here is that the Box-Jenkins process extracts the explained part of the series, leaving the residuals, which contain only what can’t be explained by the series’ own past behavior. This makes it easier to check whether these unexplained parts (residuals) are related across variables.

6. Conclusion

Many econometrics textbooks warn about specification errors in regression models, but the problem still shows up in many published papers. Granger and Newbold (1974) highlighted the risk of spurious regressions, where you get a high paired with very low Durbin-Watson statistics.

Using Python simulations, we showed some of the main causes of these spurious regressions, especially including variables that don’t belong in the model and are highly autocorrelated. We also demonstrated how these issues can completely distort hypothesis tests on the coefficients.

Hopefully, this post will help reduce the risk of spurious regressions in future econometric analyses.

7. Appendice: Python code for simulation.

#####################################################Simulation Code for table 1 #####################################################

import numpy as np
import pandas as pd
import statsmodels.api as sm
import matplotlib.pyplot as plt

np.random.seed(123)
M = 100 
n = 50
S = np.zeros(M)
for i in range(M):
#---------------------------------------------------------------
# Generate the data
#---------------------------------------------------------------
    espilon_y = np.random.normal(0, 1, n)
    espilon_x = np.random.normal(0, 1, n)

    Y = np.cumsum(espilon_y)
    X = np.cumsum(espilon_x)
#---------------------------------------------------------------
# Fit the model
#---------------------------------------------------------------
    X = sm.add_constant(X)
    model = sm.OLS(Y, X).fit()
#---------------------------------------------------------------
# Compute the statistic
#------------------------------------------------------
    S[i] = np.abs(model.params[1])/model.bse[1]


#------------------------------------------------------ 
#              Maximum value of S
#------------------------------------------------------
S_max = int(np.ceil(max(S)))

#------------------------------------------------------ 
#                Create bins
#------------------------------------------------------
bins = np.arange(0, S_max + 2, 1)  

#------------------------------------------------------
#    Compute the histogram
#------------------------------------------------------
frequency, bin_edges = np.histogram(S, bins=bins)

#------------------------------------------------------
#    Create a dataframe
#------------------------------------------------------

df = pd.DataFrame({
    "S Interval": [f"{int(bin_edges[i])}-{int(bin_edges[i+1])}" for i in range(len(bin_edges)-1)],
    "Frequency": frequency
})
print(df)
print(np.mean(S))

#####################################################Simulation Code for table 2 #####################################################

import numpy as np
import pandas as pd
import statsmodels.api as sm
from statsmodels.stats.stattools import durbin_watson
from tabulate import tabulate

np.random.seed(1)  # Pour rendre les résultats reproductibles

#------------------------------------------------------
# Definition of functions
#------------------------------------------------------

def generate_random_walk(T):
    """
    Génère une série de longueur T suivant un random walk :
        Y_t = Y_{t-1} + e_t,
    où e_t ~ N(0,1).
    """
    e = np.random.normal(0, 1, size=T)
    return np.cumsum(e)

def generate_arima_0_1_1(T):
    """
    Génère un ARIMA(0,1,1) selon la méthode de Granger & Newbold :
    la série est obtenue en additionnant une marche aléatoire et un bruit blanc indépendant.
    """
    rw = generate_random_walk(T)
    wn = np.random.normal(0, 1, size=T)
    return rw + wn

def difference(series):
    """
    Calcule la différence première d'une série unidimensionnelle.
    Retourne une série de longueur T-1.
    """
    return np.diff(series)

#------------------------------------------------------
# Paramètres
#------------------------------------------------------

T = 50           # longueur de chaque série
n_sims = 100     # nombre de simulations Monte Carlo
alpha = 0.05     # seuil de significativité

#------------------------------------------------------
# Definition of function for simulation
#------------------------------------------------------

def run_simulation_case(case_name, m_values=[1,2,3,4,5]):
    """
    case_name : un identifiant pour le type de génération :
        - 'rw-levels' : random walk (levels)
        - 'rw-diffs'  : differences of RW (white noise)
        - 'arima-levels' : ARIMA(0,1,1) en niveaux
        - 'arima-diffs'  : différences d'un ARIMA(0,1,1) => MA(1)
    
    m_values : liste du nombre de régresseurs.
    
    Retourne un DataFrame avec pour chaque m :
        - % de rejets de H0
        - Durbin-Watson moyen
        - R^2_adj moyen
        - % de R^2 > 0.1
    """
    results = []
    
    for m in m_values:
        count_reject = 0
        dw_list = []
        r2_adjusted_list = []
        
        for _ in range(n_sims):
#--------------------------------------
# 1) Generation of independents de Y_t and X_{j,t}.
#----------------------------------------
            if case_name == 'rw-levels':
                Y = generate_random_walk(T)
                Xs = [generate_random_walk(T) for __ in range(m)]
            
            elif case_name == 'rw-diffs':
                # Y et X sont les différences d'un RW, i.e. ~ white noise
                Y_rw = generate_random_walk(T)
                Y = difference(Y_rw)
                Xs = []
                for __ in range(m):
                    X_rw = generate_random_walk(T)
                    Xs.append(difference(X_rw))
                # NB : maintenant Y et Xs ont longueur T-1
                # => ajuster T_effectif = T-1
                # => on prendra T_effectif points pour la régression
            
            elif case_name == 'arima-levels':
                Y = generate_arima_0_1_1(T)
                Xs = [generate_arima_0_1_1(T) for __ in range(m)]
            
            elif case_name == 'arima-diffs':
                # Différences d'un ARIMA(0,1,1) => MA(1)
                Y_arima = generate_arima_0_1_1(T)
                Y = difference(Y_arima)
                Xs = []
                for __ in range(m):
                    X_arima = generate_arima_0_1_1(T)
                    Xs.append(difference(X_arima))
            
            # 2) Prépare les données pour la régression
            #    Selon le cas, la longueur est T ou T-1
            if case_name in ['rw-levels','arima-levels']:
                Y_reg = Y
                X_reg = np.column_stack(Xs) if m>0 else np.array([])
            else:
                # dans les cas de différences, la longueur est T-1
                Y_reg = Y
                X_reg = np.column_stack(Xs) if m>0 else np.array([])
            
            # 3) Régression OLS
            X_with_const = sm.add_constant(X_reg)  # Ajout de l'ordonnée à l'origine
            model = sm.OLS(Y_reg, X_with_const).fit()
            
            # 4) Test global F : H0 : tous les beta_j = 0
            #    On regarde si p-value < alpha
            if model.f_pvalue is not None and model.f_pvalue  0.7)
        
        results.append({
            'm': m,
            'Reject %': reject_percent,
            'Mean DW': dw_mean,
            'Mean R^2': r2_mean,
            '% R^2_adj>0.7': r2_above_0_7_percent
        })
    
    return pd.DataFrame(results)
    
#------------------------------------------------------
# Application of the simulation
#------------------------------------------------------       

cases = ['rw-levels', 'rw-diffs', 'arima-levels', 'arima-diffs']
all_results = {}

for c in cases:
    df_res = run_simulation_case(c, m_values=[1,2,3,4,5])
    all_results[c] = df_res

#------------------------------------------------------
# Store data in table
#------------------------------------------------------

for case, df_res in all_results.items():
    print(f"nn{case}")
    print(tabulate(df_res, headers='keys', tablefmt='fancy_grid'))

References

  • Granger, Clive WJ, and Paul Newbold. 1974. “Spurious Regressions in Econometrics.” Journal of Econometrics 2 (2): 111–20.
  • Knowles, EAG. 1954. “Exercises in Theoretical Statistics.” Oxford University Press.
Shape
Shape
Stay Ahead

Explore More Insights

Stay ahead with more perspectives on cutting-edge power, infrastructure, energy,  bitcoin and AI solutions. Explore these articles to uncover strategies and insights shaping the future of industries.

Shape

Fluent Bit vulnerabilities could enable full cloud takeover

Attackers could flood monitoring systems with false or misleading events, hide alerts in the noise, or even hijack the telemetry stream entirely, Katz said. The issue is now tracked as CVE-2025-12969 and awaits a severity valuation. Almost equally troubling are other flaws in the “tag” mechanism, which determines how the records are

Read More »

Ukraine Says It Hit Saratov Refinery

Ukrainian forces say they have once again attacked Rosneft PJSC’s Saratov oil refinery in Russia’s Volga region as the US pushes for a resolution to the Kremlin’s nearly four-year-old invasion of Ukraine.  “A series of explosions was recorded, followed by a fire in the target area,” Ukraine’s General Staff said in a Telegram statement on Friday, adding that the facility is involved in army supplies. The claim could not be independently verified and Rosneft didn’t immediately respond to a Bloomberg request for comment. Ukraine has stepped up attacks on Russian energy infrastructure over the past months, targeting refineries, export pipelines and sea terminals to seek to reduce the Kremlin’s oil revenues and its ability to fund the war. If Kyiv’s military forces keep up the strikes before the month ends, November will mark a new peak in the intensity of the campaign to damage Russian refineries.  The strikes are happening as Ukraine is under pressure to agree on a US-led peace deal after an original proposal drew the ire of officials in Kyiv and in Europe. US President Donald Trump earlier this week hailed “tremendous progress” in talks to iron out key issues, while his envoy Steve Witkoff is set to visit Moscow next week to meet with President Vladimir Putin.  The latest raid was the fourth attack on the Saratov refinery this month, according to Bloomberg calculations based on public data and statements. The facility has a design processing capacity of around 140,000 barrels per day.  In total, Russian oil-processing facilities have been hit at least 13 times so far this month, matching a peak in August, Bloomberg calculations show. Russian military forces, meanwhile, have been relentlessly hitting Ukraine’s infrastructure, including residential buildings and utilities, aiming to create lengthy power outages. The prospects for achieving a piece deal are still uncertain,

Read More »

Carney Loses Quebec Minister After Energy Deal

Prime Minister Mark Carney lost a cabinet minister over his oil pipeline agreement with Alberta, marking the first major fracture in his Liberal Party caucus over the government’s energy policies. Steven Guilbeault, a former environmental activist with Greenpeace, resigned his position as culture minister but will remain in Parliament. In a statement posted on social media Thursday evening, Guilbeault panned the agreement reached with Alberta, saying the government failed to consult Indigenous communities and the pipeline would pose significant environmental risks. “When I entered politics, it was because I had a deep conviction that I could make a difference in fighting climate change,” he wrote. “My commitment to leaving a better world for the future of our children and our planet remains unchanged.” Guilbeault was first elected to office in 2019, and served as both heritage minister and environment minister under former Prime Minister Justin Trudeau. He also has a high profile in the province of Quebec, a crucial electoral battleground that helped Carney win government in this year’s election. In his letter, Guilbeault noted that the government has dismantled much of his legacy as environment minister — repealing consumer carbon pricing, delaying a policy to encourage zero-emission vehicles and scrapping the oil and gas sector emissions cap. Carney thanked his former minister in a statement late Thursday. “While we may have differing views at times on how exactly we make essential progress, I am glad Steven will continue to offer his important perspectives as a Member of Parliament in our Liberal caucus,” the prime minister said.  Quebec Voice Earlier in the day, Carney had unveiled an agreement with Danielle Smith, premier of the oil-rich province of Alberta. The document pledges federal government support for a new oil pipeline to Canada’s west coast and scraps some Trudeau-era environmental regulations in exchange for Alberta’s agreement to hike

Read More »

Two Oil Tankers Suffer Mystery Blasts While in Black Sea

(Update) November 28, 2025, 6:14 PM GMT: Article updated. Two ocean-going tankers that are heavily sanctioned for carrying Russian oil suffered near-simultaneous blasts off Turkey’s Black Sea coast. The first, the 900-foot Kairos, was taking on water after an explosion, according to a local port agent report. Turkey’s Directorate General for Maritime Affairs confirmed the incident and said a second ship, the Virat, had also been struck near its coastline and was billowing smoke. The causes are unclear and a rescue operation for both ships was underway.  The pair are two of hundreds of vessels that were amassed to help keep Russia’s oil moving after it invaded Ukraine. Kairos is sanctioned by the UK and European Union, while Virat was designated by the US and EU.  DENİZCİLİK GENEL MÜDÜRLÜĞÜ@denizcilikgm  VIRAT isimli tanker, Karadeniz’de takribi 35 deniz mili açıkta isabet aldığını bildirmiş, olay yerine kurtarma unsurları ve ticari gemi yönlendirilmiştir. Gemideki 20 personelin durumu iyi olup makine dairesinde yoğun duman tespit edilmiştir. Süreç takip edilmektedir. Sent via Twitter for Android. View original tweet. It’s not the first time that ships linked to Moscow have suffered explosions this year. There was also a spate of blasts in the early months of 2025 that hit merchant ships with a history of calling at Russian ports.  It’s not yet known what happened to these vessels and, if they were attacked, who was responsible. Spain’s navy, which issues navigational warnings in the region, says there’s also a significant risk posed by floating mines in parts of the Black Sea since the conflict began. Kairos is a Suezmax-class vessel whose previous voyage was from the Russian port of Novorossiysk to Paradip in India, hauling Moscow’s flagship crude grade Urals. It was heading back to the Russian port to load its next cargo at the time of the incident,

Read More »

Oil Notches Fourth Monthly Drop

Oil posted a fourth monthly loss as traders looked ahead to an OPEC+ meeting this weekend and assessed how the potential of easing geopolitical tensions from Kyiv to Caracas may impact an oversupplied market. West Texas Intermediate edged down to settle below $59 a barrel, after earlier gaining as much as 1.7%, to close out the longest streak of monthly drops since March 2023. The commodity slid to intra-day lows minutes before settlement as The New York Times reported that US President Donald Trump and Venezuelan counterpart Nicolás Maduro discussed a potential meeting in a call last week. A de-escalation between the Trump administration and the oil-rich South American country would sap a major risk premium out of oil prices.  The late-day dip capped off a choppy trading session, marked by thin holiday volumes and an hours-long outage on Chicago Mercantile Exchange’s trading platform that roiled global markets. The halt — which the company said was a result of a cooling issue in a data center — also impacted gasoline and diesel futures that are due to expire on Friday.  OPEC+ nations are set to meet virtually on Sunday and will probably stick with a plan to pause output increases in early 2026, delegates said. With that decision locked in, a key focus may be a long-term review of members’ capacity. US oil has fallen 18% this year, with prices hurt by expectations for a global glut after OPEC+ restarted capacity, while drillers outside the alliance also added supplies.  On Ukraine, Russian President Vladimir Putin said that US President Donald Trump’s proposals for ending Moscow’s war could be the basis for future agreements and expressed an openness to talks, though sticking points that led to stalemates in previous rounds remain. US presidential envoy Steve Witkoff is expected to visit Moscow next week.  The

Read More »

CME Futures Outage Disrupts Trading

(Update) November 28, 2025, 11:00 AM GMT: Article updated. Trading of futures and options on the Chicago Mercantile Exchange was halted by a data-center fault, causing hours of disruption to markets across equities, foreign exchange, bonds and commodities. The malfunction was caused by cooling system problems at a data center in the Chicago area, according to facility operator CyrusOne. Engineering teams have restarted several chillers and deployed temporary cooling equipment, a spokesperson said, without giving a time for the resumption of normal operations.  The halt is already longer than a similar, hours-long outage due to a technical error back in 2019 and underscores the reach of CME Group Inc. and its Globex electronic trading platform. It triggered widespread frustration as market participants contemplated the prospect of a lost trading session. Millions of contracts tracking the S&P 500, Dow Jones Industrial Average and Nasdaq 100 trade every weekday virtually around the clock on the CME, one of the world’s largest derivatives exchanges. “It’s a bit like flying dark,” said Thomas Helaine, head of equity sales at TP ICAP Europe in Paris. “When you’re trading cash equity like us, US futures give you an indication of where the market is going before the open. I can only imagine how complicated it must be for derivatives desks.” The outage halted trading of US Treasury futures, while European and UK bond markets that trade on a different exchange were unaffected. EBS, a platform used in foreign exchange, was impacted, hurting price discovery in the market. For some traders, the timing of the disruption on Friday could cause particular inconvenience if it lasts, due to the need to roll positions from one monthly contract to another.  “Traders sitting with a position are certainly quite angry,” said Gnanasekar Thiagarajan, head of trading and hedging strategies at Kaleesuwari Intercontinental. Gold saw

Read More »

Petrobras Slumps After Unveiling $109B Spending Plan

Brazilian oil major Petrobras announced a 2% decrease in its next five-year investment plan to $109 billion, putting dividend payments in doubt at a time of lower oil prices. Shares fell. The state-controlled oil producer is caught between the government’s desire to grow the economy – especially ahead of a 2026 presidential election – and investors who demand high dividends and low debt. While Petrobras announced a regular dividend payout of at least $45 billion for the 2026-2030 period, similar to the previous plan, it didn’t commit to pay any extraordinary payouts to shareholders.  Petrobras shares slid as much as 3.4% in Sao Paulo on Friday, the largest intraday drop since August, while Brent prices were are slightly lower. “The absence of short-term capex optimization could result in single-digit dividend yields ,” Itau Unibanco Holding SA said in a note to clients. “This could be perceived as disappointing by investors.” Petroleo Brasileiro SA, as it is formally known, will direct $91 billion of the total capital expenditure to projects under implementation, of which $10 billion will still need budget confirmation subject to a financing analysis. The rest is still under analysis “with a lower degree of maturity,” it said in a filing on Thursday. The spending plan is being closely watched by investors as it has an important political dimension in Brazil. The company is a major source of cash for the federal budget. It is the first time Petrobras has reduced its five-year budget after President Luiz Inacio Lula da Silva took office in 2023.  The previous plan was based on an oil price assumption of $83 a barrel, while Brent crude is currently trading near $63.  Petrobras earmarked 71.6% of the 2026-2030 plan, or $78 billion, for exploration and production. That includes boosting output at its deep-water fields

Read More »

Microsoft loses two senior AI infrastructure leaders as data center pressures mount

Microsoft did not immediately respond to a request for comment. Microsoft’s constraints Analysts say the twin departures mark a significant setback for Microsoft at a critical moment in the AI data center race, with pressure mounting from both OpenAI’s model demands and Google’s infrastructure scale. “Losing some of the best professionals working on this challenge could set Microsoft back,” said Neil Shah, partner and co-founder at Counterpoint Research. “Solving the energy wall is not trivial, and there may have been friction or strategic differences that contributed to their decision to move on, especially if they saw an opportunity to make a broader impact and do so more lucratively at a company like Nvidia.” Even so, Microsoft has the depth and ecosystem strength to continue doubling down on AI data centers, said Prabhu Ram, VP for industry research at Cybermedia Research. According to Sanchit Gogia, chief analyst at Greyhound Research, the departures come at a sensitive moment because Microsoft is trying to expand its AI infrastructure faster than physical constraints allow. “The executives who have left were central to GPU cluster design, data center engineering, energy procurement, and the experimental power and cooling approaches Microsoft has been pursuing to support dense AI workloads,” Gogia said. “Their exit coincides with pressures the company has already acknowledged publicly. GPUs are arriving faster than the company can energize the facilities that will house them, and power availability has overtaken chip availability as the real bottleneck.”

Read More »

What is Edge AI? When the cloud isn’t close enough

Many edge devices can periodically send summarized or selected inference output data back to a central system for model retraining or refinement. That feedback loop helps the model improve over time while still keeping most decisions local. And to run efficiently on constrained edge hardware, the AI model is often pre-processed by techniques such as quantization (which reduces precision), pruning (which removes redundant parameters), or knowledge distillation (which trains a smaller model to mimic a larger one). These optimizations reduce the model’s memory, compute, and power demands so it can run more easily on an edge device. What technologies make edge AI possible? The concept of the “edge” always assumes that edge devices are less computationally powerful than data centers and cloud platforms. While that remains true, overall improvements in computational hardware have made today’s edge devices much more capable than those designed just a few years ago. In fact, a whole host of technological developments have come together to make edge AI a reality. Specialized hardware acceleration. Edge devices now ship with dedicated AI-accelerators (NPUs, TPUs, GPU cores) and system-on-chip units tailored for on-device inference. For example, companies like Arm have integrated AI-acceleration libraries into standard frameworks so models can run efficiently on Arm-based CPUs. Connectivity and data architecture. Edge AI often depends on durable, low-latency links (e.g., 5G, WiFi 6, LPWAN) and architectures that move compute closer to data. Merging edge nodes, gateways, and local servers means less reliance on distant clouds. And technologies like Kubernetes can provide a consistent management plane from the data center to remote locations. Deployment, orchestration, and model lifecycle tooling. Edge AI deployments must support model-update delivery, device and fleet monitoring, versioning, rollback and secure inference — especially when orchestrated across hundreds or thousands of locations. VMware, for instance, is offering traffic management

Read More »

Networks, AI, and metaversing

Our first, conservative, view says that AI’s network impact is largely confined to the data center, to connect clusters of GPU servers and the data they use as they crunch large language models. It’s all “horizontal” traffic; one TikTok challenge would generate way more traffic in the wide area. WAN costs won’t rise for you as an enterprise, and if you’re a carrier you won’t be carrying much new, so you don’t have much service revenue upside. If you don’t host AI on premises, you can pretty much dismiss its impact on your network. Contrast that with the radical metaverse view, our third view. Metaverses and AR/VR transform AI missions, and network services, from transaction processing to event processing, because the real world is a bunch of events pushing on you. They also let you visualize the way that process control models (digital twins) relate to the real world, which is critical if the processes you’re modeling involve human workers who rely on their visual sense. Could it be that the reason Meta is willing to spend on AI, is that the most credible application of AI, and the most impactful for networks, is the metaverse concept? In any event, this model of AI, by driving the users’ experiences and activities directly, demands significant edge connectivity, so you could expect it to have a major impact on network requirements. In fact, just dipping your toes into a metaverse could require a major up-front network upgrade. Networks carry traffic. Traffic is messages. More messages, more traffic, more infrastructure, more service revenue…you get the picture. Door number one, to the AI giant future, leads to nothing much in terms of messages. Door number three, metaverses and AR/VR, leads to a message, traffic, and network revolution. I’ll bet that most enterprises would doubt

Read More »

Microsoft’s Fairwater Atlanta and the Rise of the Distributed AI Supercomputer

Microsoft’s second Fairwater data center in Atlanta isn’t just “another big GPU shed.” It represents the other half of a deliberate architectural experiment: proving that two massive AI campuses, separated by roughly 700 miles, can operate as one coherent, distributed supercomputer. The Atlanta installation is the latest expression of Microsoft’s AI-first data center design: purpose-built for training and serving frontier models rather than supporting mixed cloud workloads. It links directly to the original Fairwater campus in Wisconsin, as well as to earlier generations of Azure AI supercomputers, through a dedicated AI WAN backbone that Microsoft describes as the foundation of a “planet-scale AI superfactory.” Inside a Fairwater Site: Preparing for Multi-Site Distribution Efficient multi-site training only works if each individual site behaves as a clean, well-structured unit. Microsoft’s intra-site design is deliberately simplified so that cross-site coordination has a predictable abstraction boundary—essential for treating multiple campuses as one distributed AI system. Each Fairwater installation presents itself as a single, flat, high-regularity cluster: Up to 72 NVIDIA Blackwell GPUs per rack, using GB200 NVL72 rack-scale systems. NVLink provides the ultra-low-latency, high-bandwidth scale-up fabric within the rack, while the Spectrum-X Ethernet stack handles scale-out. Each rack delivers roughly 1.8 TB/s of GPU-to-GPU bandwidth and exposes a multi-terabyte pooled memory space addressable via NVLink—critical for large-model sharding, activation checkpointing, and parallelism strategies. Racks feed into a two-tier Ethernet scale-out network offering 800 Gbps GPU-to-GPU connectivity with very low hop counts, engineered to scale to hundreds of thousands of GPUs without encountering the classic port-count and topology constraints of traditional Clos fabrics. Microsoft confirms that the fabric relies heavily on: SONiC-based switching and a broad commodity Ethernet ecosystem to avoid vendor lock-in and accelerate architectural iteration. Custom network optimizations, such as packet trimming, packet spray, high-frequency telemetry, and advanced congestion-control mechanisms, to prevent collective

Read More »

Land & Expand: Hyperscale, AI Factory, Megascale

Land & Expand is Data Center Frontier’s periodic roundup of notable North American data center development activity, tracking the newest sites, land plays, retrofits, and hyperscale campus expansions shaping the industry’s build cycle. October delivered a steady cadence of announcements, with several megascale projects advancing from concept to commitment. The month was defined by continued momentum in OpenAI and Oracle’s Stargate initiative (now spanning multiple U.S. regions) as well as major new investments from Google, Meta, DataBank, and emerging AI cloud players accelerating high-density reuse strategies. The result is a clearer picture of how the next wave of AI-first infrastructure is taking shape across the country. Google Begins $4B West Memphis Hyperscale Buildout Google formally broke ground on its $4 billion hyperscale campus in West Memphis, Arkansas, marking the company’s first data center in the state and the anchor for a new Mid-South operational hub. The project spans just over 1,000 acres, with initial site preparation and utility coordination already underway. Google and Entergy Arkansas confirmed a 600 MW solar generation partnership, structured to add dedicated renewable supply to the regional grid. As part of the launch, Google announced a $25 million Energy Impact Fund for local community affordability programs and energy-resilience improvements—an unusually early community-benefit commitment for a first-phase hyperscale project. Cooling specifics have not yet been made public. Water sourcing—whether reclaimed, potable, or hybrid seasonal mode—remains under review, as the company finalizes environmental permits. Public filings reference a large-scale onsite water treatment facility, similar to Google’s deployments in The Dalles and Council Bluffs. Local governance documents show that prior to the October announcement, West Memphis approved a 30-year PILOT via Groot LLC (Google’s land assembly entity), with early filings referencing a typical placeholder of ~50 direct jobs. At launch, officials emphasized hundreds of full-time operations roles and thousands

Read More »

The New Digital Infrastructure Geography: Green Street’s David Guarino on AI Demand, Power Scarcity, and the Next Phase of Data Center Growth

As the global data center industry races through its most frenetic build cycle in history, one question continues to define the market’s mood: is this the peak of an AI-fueled supercycle, or the beginning of a structurally different era for digital infrastructure? For Green Street Managing Director and Head of Global Data Center and Tower Research David Guarino, the answer—based firmly on observable fundamentals—is increasingly clear. Demand remains blisteringly strong. Capital appetite is deepening. And the very definition of a “data center market” is shifting beneath the industry’s feet. In a wide-ranging discussion with Data Center Frontier, Guarino outlined why data centers continue to stand out in the commercial real estate landscape, how AI is reshaping underwriting and development models, why behind-the-meter power is quietly reorganizing the U.S. map, and what Green Street sees ahead for rents, REITs, and the next wave of hyperscale expansion. A ‘Safe’ Asset in an Uncertain CRE Landscape Among institutional investors, the post-COVID era was the moment data centers stepped decisively out of “niche” territory. Guarino notes that pandemic-era reliance on digital services crystallized a structural recognition: data centers deliver stable, predictable cash flows, anchored by the highest-credit tenants in global real estate. Hyperscalers today dominate new leasing and routinely sign 15-year (or longer) contracts, a duration largely unmatched across CRE categories. When compared with one-year apartment leases, five-year office leases, or mall anchor terms, the stability story becomes plain. “These are AAA-caliber companies signing the longest leases in the sector’s history,” Guarino said. “From a real estate point of view, that combination of tenant quality and lease duration continues to position the asset class as uniquely durable.” And development returns remain exceptional. Even without assuming endless AI growth, the math works: strong demand, rising rents, and high-credit tenants create unusually predictable performance relative to

Read More »

Microsoft will invest $80B in AI data centers in fiscal 2025

And Microsoft isn’t the only one that is ramping up its investments into AI-enabled data centers. Rival cloud service providers are all investing in either upgrading or opening new data centers to capture a larger chunk of business from developers and users of large language models (LLMs).  In a report published in October 2024, Bloomberg Intelligence estimated that demand for generative AI would push Microsoft, AWS, Google, Oracle, Meta, and Apple would between them devote $200 billion to capex in 2025, up from $110 billion in 2023. Microsoft is one of the biggest spenders, followed closely by Google and AWS, Bloomberg Intelligence said. Its estimate of Microsoft’s capital spending on AI, at $62.4 billion for calendar 2025, is lower than Smith’s claim that the company will invest $80 billion in the fiscal year to June 30, 2025. Both figures, though, are way higher than Microsoft’s 2020 capital expenditure of “just” $17.6 billion. The majority of the increased spending is tied to cloud services and the expansion of AI infrastructure needed to provide compute capacity for OpenAI workloads. Separately, last October Amazon CEO Andy Jassy said his company planned total capex spend of $75 billion in 2024 and even more in 2025, with much of it going to AWS, its cloud computing division.

Read More »

John Deere unveils more autonomous farm machines to address skill labor shortage

Join our daily and weekly newsletters for the latest updates and exclusive content on industry-leading AI coverage. Learn More Self-driving tractors might be the path to self-driving cars. John Deere has revealed a new line of autonomous machines and tech across agriculture, construction and commercial landscaping. The Moline, Illinois-based John Deere has been in business for 187 years, yet it’s been a regular as a non-tech company showing off technology at the big tech trade show in Las Vegas and is back at CES 2025 with more autonomous tractors and other vehicles. This is not something we usually cover, but John Deere has a lot of data that is interesting in the big picture of tech. The message from the company is that there aren’t enough skilled farm laborers to do the work that its customers need. It’s been a challenge for most of the last two decades, said Jahmy Hindman, CTO at John Deere, in a briefing. Much of the tech will come this fall and after that. He noted that the average farmer in the U.S. is over 58 and works 12 to 18 hours a day to grow food for us. And he said the American Farm Bureau Federation estimates there are roughly 2.4 million farm jobs that need to be filled annually; and the agricultural work force continues to shrink. (This is my hint to the anti-immigration crowd). John Deere’s autonomous 9RX Tractor. Farmers can oversee it using an app. While each of these industries experiences their own set of challenges, a commonality across all is skilled labor availability. In construction, about 80% percent of contractors struggle to find skilled labor. And in commercial landscaping, 86% of landscaping business owners can’t find labor to fill open positions, he said. “They have to figure out how to do

Read More »

2025 playbook for enterprise AI success, from agents to evals

Join our daily and weekly newsletters for the latest updates and exclusive content on industry-leading AI coverage. Learn More 2025 is poised to be a pivotal year for enterprise AI. The past year has seen rapid innovation, and this year will see the same. This has made it more critical than ever to revisit your AI strategy to stay competitive and create value for your customers. From scaling AI agents to optimizing costs, here are the five critical areas enterprises should prioritize for their AI strategy this year. 1. Agents: the next generation of automation AI agents are no longer theoretical. In 2025, they’re indispensable tools for enterprises looking to streamline operations and enhance customer interactions. Unlike traditional software, agents powered by large language models (LLMs) can make nuanced decisions, navigate complex multi-step tasks, and integrate seamlessly with tools and APIs. At the start of 2024, agents were not ready for prime time, making frustrating mistakes like hallucinating URLs. They started getting better as frontier large language models themselves improved. “Let me put it this way,” said Sam Witteveen, cofounder of Red Dragon, a company that develops agents for companies, and that recently reviewed the 48 agents it built last year. “Interestingly, the ones that we built at the start of the year, a lot of those worked way better at the end of the year just because the models got better.” Witteveen shared this in the video podcast we filmed to discuss these five big trends in detail. Models are getting better and hallucinating less, and they’re also being trained to do agentic tasks. Another feature that the model providers are researching is a way to use the LLM as a judge, and as models get cheaper (something we’ll cover below), companies can use three or more models to

Read More »

OpenAI’s red teaming innovations define new essentials for security leaders in the AI era

Join our daily and weekly newsletters for the latest updates and exclusive content on industry-leading AI coverage. Learn More OpenAI has taken a more aggressive approach to red teaming than its AI competitors, demonstrating its security teams’ advanced capabilities in two areas: multi-step reinforcement and external red teaming. OpenAI recently released two papers that set a new competitive standard for improving the quality, reliability and safety of AI models in these two techniques and more. The first paper, “OpenAI’s Approach to External Red Teaming for AI Models and Systems,” reports that specialized teams outside the company have proven effective in uncovering vulnerabilities that might otherwise have made it into a released model because in-house testing techniques may have missed them. In the second paper, “Diverse and Effective Red Teaming with Auto-Generated Rewards and Multi-Step Reinforcement Learning,” OpenAI introduces an automated framework that relies on iterative reinforcement learning to generate a broad spectrum of novel, wide-ranging attacks. Going all-in on red teaming pays practical, competitive dividends It’s encouraging to see competitive intensity in red teaming growing among AI companies. When Anthropic released its AI red team guidelines in June of last year, it joined AI providers including Google, Microsoft, Nvidia, OpenAI, and even the U.S.’s National Institute of Standards and Technology (NIST), which all had released red teaming frameworks. Investing heavily in red teaming yields tangible benefits for security leaders in any organization. OpenAI’s paper on external red teaming provides a detailed analysis of how the company strives to create specialized external teams that include cybersecurity and subject matter experts. The goal is to see if knowledgeable external teams can defeat models’ security perimeters and find gaps in their security, biases and controls that prompt-based testing couldn’t find. What makes OpenAI’s recent papers noteworthy is how well they define using human-in-the-middle

Read More »