Heteroscedasticity & Transformations
Financial data often has problems with heteroscedasticity also spelled Heteroskedasticity (funnel shaped). Performing transformations is necessary however I often have a hard time explaining what the transformation is actually doing. This video helps show what is happening during a log transformation.
After watching the data literally “transform” it was much easier to grasp exactly what was happening and how it would help. Just remember you’ll have to transform it back if you wish to interpret the values. While the below video was created using SYSTAT, I transform data so often I have some killer SPSS macros which transform data effortlessly.
You want your data to be normally distributed around the line which is “homosecasticity“.
If you’re interested in reading more, SAGE has a specific book on Heteroscedasticity & transformations