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CHAPTER6ECONOMETRICSx
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Dummy Variable Regression Models
Dummy, or indicator, variables take on values of 0 or 1to indicate the presence or absence of a quality.
Yi = B1 + B2 Di + B3Xi + ui
Di = 1 for female0 for male
They can be included in regressionsjust like quantitative variables.
Di = 1 for prior to 20010 for 2001 and later
OR
A Dummy Variable Indicates Change in Intercept
Yi = 60 + 30 Di - 0.4 Xi + ui
20 40 60 80 100120
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X
Y If D = 0
Y = 60 + 30 D - 0.4 X
Y = 60 – 0.4 X
D = 0
D = 1
If D = 1
Y = 60 + 30 D - 0.4 X
Y = 90 - 0.4 X
B2=30 is the differential intercept coefficient.
A Dummy Variable Can Allow for Change in Slope, Too
Yi = 60 + 30 Di – 0.4 Xi + 0.3(DiXi) + ui
20 40 60 80 100120
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40
60
80
100
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X
Y If D = 0
Y = 60 + 30 D – 0.4 X + 0.3 DX
Y = 60 – 0.4 X
D = 0
D = 1
B4=0.3 is the differential slope coefficient.
If D = 1
Y = 60 + 30 D – 0.4 X + 0.3 DX
Y = 60 – 0.1 X
Yi = B1 + B2 Di + B3Xi + ui
Di = 0 for first quarter 2 for third quarter1 for second quarter 3 for fourth quarter
Variables with More than Two Classes
Don’t allow the dummy variable to take on multiple values:
This assumes a pattern in the effect that might not exist.
Instead, use several indicator variables.
D2i = 1 if 2nd qrt0 otherwise
Yi = B1 + B2 D2i + B3D3i + B4D4i + B5Xi + ui
D3i = 1 if 3rd qrt0 otherwise
D4i = 1 for 4th qrt0 otherwise