Introductory Econometrics for Finance _ Cambridge University _ press(2008)
Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ......
Transcript of Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ......
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Introductory EconometricsLecture 1
Xiaoxia Shi
University of Wisconsin - Madison
09/02/2010
Lecture (1) Intro Metrics 09/02/2010 1 / 25
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What is Econometrics?
What is Econometrics?
Econometrics employs statistical methods
to analyze data
in order to
1 estimate economic relationships,
2 evaluate government and business policies,
3 test economic theories, and
4 make predictions and forecasts.
Lecture (1) Intro Metrics 09/02/2010 2 / 25
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What is Econometrics?
What is Econometrics?
Econometrics employs statistical methods
to analyze data
in order to
1 estimate economic relationships,
2 evaluate government and business policies,
3 test economic theories, and
4 make predictions and forecasts.
Lecture (1) Intro Metrics 09/02/2010 2 / 25
![Page 4: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/4.jpg)
What is Econometrics?
What is Econometrics?
Econometrics employs statistical methods
to analyze data
in order to
1 estimate economic relationships,
2 evaluate government and business policies,
3 test economic theories, and
4 make predictions and forecasts.
Lecture (1) Intro Metrics 09/02/2010 2 / 25
![Page 5: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/5.jpg)
What is Econometrics?
What is Econometrics?
Econometrics employs statistical methods
to analyze data
in order to
1 estimate economic relationships,
2 evaluate government and business policies,
3 test economic theories, and
4 make predictions and forecasts.
Lecture (1) Intro Metrics 09/02/2010 2 / 25
![Page 6: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/6.jpg)
What is Econometrics?
What is Econometrics?
Econometrics employs statistical methods
to analyze data
in order to
1 estimate economic relationships,
2 evaluate government and business policies,
3 test economic theories, and
4 make predictions and forecasts.
Lecture (1) Intro Metrics 09/02/2010 2 / 25
![Page 7: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/7.jpg)
What is Econometrics?
What is Econometrics?
Econometrics employs statistical methods
to analyze data
in order to
1 estimate economic relationships,
2 evaluate government and business policies,
3 test economic theories, and
4 make predictions and forecasts.
Lecture (1) Intro Metrics 09/02/2010 2 / 25
![Page 8: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/8.jpg)
What is Econometrics?
What is Econometrics?
Econometrics employs statistical methods
to analyze data
in order to
1 estimate economic relationships,
2 evaluate government and business policies,
3 test economic theories, and
4 make predictions and forecasts.
Lecture (1) Intro Metrics 09/02/2010 2 / 25
![Page 9: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/9.jpg)
Data that Econometricians Use
Four types of Data:
Cross-Sectional Data
Time Series Data
Pooled Cross Sections
Panel Data
Lecture (1) Intro Metrics 09/02/2010 3 / 25
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Data that Econometricians Use
Four types of Data:
Cross-Sectional Data
Time Series Data
Pooled Cross Sections
Panel Data
Lecture (1) Intro Metrics 09/02/2010 3 / 25
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Data that Econometricians Use
Four types of Data:
Cross-Sectional Data
Time Series Data
Pooled Cross Sections
Panel Data
Lecture (1) Intro Metrics 09/02/2010 3 / 25
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Data that Econometricians Use
Four types of Data:
Cross-Sectional Data
Time Series Data
Pooled Cross Sections
Panel Data
Lecture (1) Intro Metrics 09/02/2010 3 / 25
![Page 13: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/13.jpg)
Random Variables
What is a random variable?
In the linear regression:
Y = β0 + β1X + U
are Y ,X ,U random variables?
are β0, β1 random variables?
Are the OLS estimators of β0, β1 random variables?
Lecture (1) Intro Metrics 09/02/2010 4 / 25
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Random Variables
What is a random variable?
In the linear regression:
Y = β0 + β1X + U
are Y ,X ,U random variables?
are β0, β1 random variables?
Are the OLS estimators of β0, β1 random variables?
Lecture (1) Intro Metrics 09/02/2010 4 / 25
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Random Variables
What is a random variable?
In the linear regression:
Y = β0 + β1X + U
are Y ,X ,U random variables?
are β0, β1 random variables?
Are the OLS estimators of β0, β1 random variables?
Lecture (1) Intro Metrics 09/02/2010 4 / 25
![Page 16: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/16.jpg)
Random Variables
What is a random variable?
In the linear regression:
Y = β0 + β1X + U
are Y ,X ,U random variables?
are β0, β1 random variables?
Are the OLS estimators of β0, β1 random variables?
Lecture (1) Intro Metrics 09/02/2010 4 / 25
![Page 17: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/17.jpg)
Expectation
What is Expectation?
What�s the di¤erence between expectation and sample average?
Properties of expectation:
E (aX + bY + c) =?
What�s conditional Expectation?
Law of Iterated Expectation:
E [E (Y jX )] = E (Y )
Lecture (1) Intro Metrics 09/02/2010 5 / 25
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Expectation
What is Expectation?
What�s the di¤erence between expectation and sample average?
Properties of expectation:
E (aX + bY + c) =?
What�s conditional Expectation?
Law of Iterated Expectation:
E [E (Y jX )] = E (Y )
Lecture (1) Intro Metrics 09/02/2010 5 / 25
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Expectation
What is Expectation?
What�s the di¤erence between expectation and sample average?
Properties of expectation:
E (aX + bY + c) =?
What�s conditional Expectation?
Law of Iterated Expectation:
E [E (Y jX )] = E (Y )
Lecture (1) Intro Metrics 09/02/2010 5 / 25
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Expectation
What is Expectation?
What�s the di¤erence between expectation and sample average?
Properties of expectation:
E (aX + bY + c) =?
What�s conditional Expectation?
Law of Iterated Expectation:
E [E (Y jX )] = E (Y )
Lecture (1) Intro Metrics 09/02/2010 5 / 25
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Variance, Covariance and Correlation
What�s the variance of a random variable X?
What�s the covariance of random variable X and Y ?Properties of variances:
Var (aX + bY + c) =?
What�s the correlation between X and Y ?
ρ (X ,Y ) =??
Lecture (1) Intro Metrics 09/02/2010 6 / 25
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Variance, Covariance and Correlation
What�s the variance of a random variable X?
What�s the covariance of random variable X and Y ?
Properties of variances:
Var (aX + bY + c) =?
What�s the correlation between X and Y ?
ρ (X ,Y ) =??
Lecture (1) Intro Metrics 09/02/2010 6 / 25
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Variance, Covariance and Correlation
What�s the variance of a random variable X?
What�s the covariance of random variable X and Y ?Properties of variances:
Var (aX + bY + c) =?
What�s the correlation between X and Y ?
ρ (X ,Y ) =??
Lecture (1) Intro Metrics 09/02/2010 6 / 25
![Page 24: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/24.jpg)
Variance, Covariance and Correlation
What�s the variance of a random variable X?
What�s the covariance of random variable X and Y ?Properties of variances:
Var (aX + bY + c) =?
What�s the correlation between X and Y ?
ρ (X ,Y ) =??
Lecture (1) Intro Metrics 09/02/2010 6 / 25
![Page 25: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/25.jpg)
Simple Regression
We want to know the parameters β0 and β1 in the populationequation:
Y = β0 + β1X + U
We have a sample fXi ,Yigni=1. How do we estimate the parameters?Ordinary least square (OLS):
β0, β1 minimizesn
∑i=1(Yi � b0 � b1Xi )2
What is the formula for the OLS estimators? (hint: take �rstderivatives and set to zero)
β0 =?, β1 =?
Lecture (1) Intro Metrics 09/02/2010 7 / 25
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Simple Regression
We want to know the parameters β0 and β1 in the populationequation:
Y = β0 + β1X + U
We have a sample fXi ,Yigni=1. How do we estimate the parameters?
Ordinary least square (OLS):
β0, β1 minimizesn
∑i=1(Yi � b0 � b1Xi )2
What is the formula for the OLS estimators? (hint: take �rstderivatives and set to zero)
β0 =?, β1 =?
Lecture (1) Intro Metrics 09/02/2010 7 / 25
![Page 27: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/27.jpg)
Simple Regression
We want to know the parameters β0 and β1 in the populationequation:
Y = β0 + β1X + U
We have a sample fXi ,Yigni=1. How do we estimate the parameters?Ordinary least square (OLS):
β0, β1 minimizesn
∑i=1(Yi � b0 � b1Xi )2
What is the formula for the OLS estimators? (hint: take �rstderivatives and set to zero)
β0 =?, β1 =?
Lecture (1) Intro Metrics 09/02/2010 7 / 25
![Page 28: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/28.jpg)
Simple Regression
We want to know the parameters β0 and β1 in the populationequation:
Y = β0 + β1X + U
We have a sample fXi ,Yigni=1. How do we estimate the parameters?Ordinary least square (OLS):
β0, β1 minimizesn
∑i=1(Yi � b0 � b1Xi )2
What is the formula for the OLS estimators? (hint: take �rstderivatives and set to zero)
β0 =?, β1 =?
Lecture (1) Intro Metrics 09/02/2010 7 / 25
![Page 29: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/29.jpg)
Another Way to Derive OLS Estimators
Population Moments: the true parameters (β0, β1) solve:
E (Y � β0 � β1X ) = 0
E�YX � β0X � β1X
2� = 0
Sample analogue: β0, β1 solves:
n�1n
∑i=1(Yi � b0 � b1Xi ) = 0
n�1n
∑i=1
�YiXi � b0Xi � b1X 2i
�= 0
β0 =?, β1 =?
Lecture (1) Intro Metrics 09/02/2010 8 / 25
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Another Way to Derive OLS Estimators
Population Moments: the true parameters (β0, β1) solve:
E (Y � β0 � β1X ) = 0
E�YX � β0X � β1X
2� = 0
Sample analogue: β0, β1 solves:
n�1n
∑i=1(Yi � b0 � b1Xi ) = 0
n�1n
∑i=1
�YiXi � b0Xi � b1X 2i
�= 0
β0 =?, β1 =?
Lecture (1) Intro Metrics 09/02/2010 8 / 25
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Another Way to Derive OLS Estimators
Population Moments: the true parameters (β0, β1) solve:
E (Y � β0 � β1X ) = 0
E�YX � β0X � β1X
2� = 0
Sample analogue: β0, β1 solves:
n�1n
∑i=1(Yi � b0 � b1Xi ) = 0
n�1n
∑i=1
�YiXi � b0Xi � b1X 2i
�= 0
β0 =?, β1 =?
Lecture (1) Intro Metrics 09/02/2010 8 / 25
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Residual and Predicted Value
What is "regression residual"?
Ui = Yi � β0 � β1Xi
What is "predicted value of Yi"?
Yi = Ui= β0 + β1Xi
Now,n
∑i=1Ui =?,
n
∑i=1UiXi =?
Lecture (1) Intro Metrics 09/02/2010 9 / 25
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Residual and Predicted Value
What is "regression residual"?
Ui = Yi � β0 � β1Xi
What is "predicted value of Yi"?
Yi = Ui= β0 + β1Xi
Now,n
∑i=1Ui =?,
n
∑i=1UiXi =?
Lecture (1) Intro Metrics 09/02/2010 9 / 25
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Residual and Predicted Value
What is "regression residual"?
Ui = Yi � β0 � β1Xi
What is "predicted value of Yi"?
Yi = Ui= β0 + β1Xi
Now,n
∑i=1Ui =?,
n
∑i=1UiXi =?
Lecture (1) Intro Metrics 09/02/2010 9 / 25
![Page 35: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/35.jpg)
Residual and Predicted Value
What is "regression residual"?
Ui = Yi � β0 � β1Xi
What is "predicted value of Yi"?
Yi = Ui= β0 + β1Xi
Now,n
∑i=1Ui =?,
n
∑i=1UiXi =?
Lecture (1) Intro Metrics 09/02/2010 9 / 25
![Page 36: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/36.jpg)
Residual and Predicted Value
What is "regression residual"?
Ui = Yi � β0 � β1Xi
What is "predicted value of Yi"?
Yi = Ui= β0 + β1Xi
Now,n
∑i=1Ui =?,
n
∑i=1UiXi =?
Lecture (1) Intro Metrics 09/02/2010 9 / 25
![Page 37: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/37.jpg)
Changing Units of Measurement
Holding other variables constant, if smoking one more cigarettereducing baby birth weight by 1 pound, what�s the e¤ect of smokingone pack (20) more of cigarette?
Y = β0 + β1X + U = β0 + (20β1)� X20
�+ U
What�s the e¤ect of smoking one more cigarette on baby birth weightmeasured by grams?
(450Y )450
= β0 + β1X + U )(450Y ) = 450β0 + 450β1X + 450U
Lecture (1) Intro Metrics 09/02/2010 10 / 25
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Changing Units of Measurement
Holding other variables constant, if smoking one more cigarettereducing baby birth weight by 1 pound, what�s the e¤ect of smokingone pack (20) more of cigarette?
Y = β0 + β1X + U = β0 + (20β1)� X20
�+ U
What�s the e¤ect of smoking one more cigarette on baby birth weightmeasured by grams?
(450Y )450
= β0 + β1X + U )(450Y ) = 450β0 + 450β1X + 450U
Lecture (1) Intro Metrics 09/02/2010 10 / 25
![Page 39: Introductory Econometrics - SSCCxshi/econ410/review.pdf · Introductory Econometrics Lecture 1 ... Pooled Cross Sections Panel Data ... Simple Regression We want to know the parameters](https://reader031.fdocuments.us/reader031/viewer/2022013117/5b7157fc7f8b9a674d8b7589/html5/thumbnails/39.jpg)
Changing Units of Measurement
Holding other variables constant, if smoking one more cigarettereducing baby birth weight by 1 pound, what�s the e¤ect of smokingone pack (20) more of cigarette?
Y = β0 + β1X + U = β0 + (20β1)� X20
�+ U
What�s the e¤ect of smoking one more cigarette on baby birth weightmeasured by grams?
(450Y )450
= β0 + β1X + U )(450Y ) = 450β0 + 450β1X + 450U
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Changing Units of Measurement
Holding other variables constant, if smoking one more cigarettereducing baby birth weight by 1 pound, what�s the e¤ect of smokingone pack (20) more of cigarette?
Y = β0 + β1X + U = β0 + (20β1)� X20
�+ U
What�s the e¤ect of smoking one more cigarette on baby birth weightmeasured by grams?
(450Y )450
= β0 + β1X + U )(450Y ) = 450β0 + 450β1X + 450U
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Log-forms
How to interpret coe¢ cients obtained from the regression:
log (Y ) = β0 + β1X + U?
one unit of change in X changes Y by β1 � 100%
How to interpret coe¢ cients obtained from the regression:
Y = β0 + β1 log(X ) + U?
one percent change in X changes Y by β1/100 units
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Log-forms
How to interpret coe¢ cients obtained from the regression:
log (Y ) = β0 + β1X + U?
one unit of change in X changes Y by β1 � 100%
How to interpret coe¢ cients obtained from the regression:
Y = β0 + β1 log(X ) + U?
one percent change in X changes Y by β1/100 units
Lecture (1) Intro Metrics 09/02/2010 11 / 25
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Log-forms
How to interpret coe¢ cients obtained from the regression:
log (Y ) = β0 + β1X + U?
one unit of change in X changes Y by β1 � 100%
How to interpret coe¢ cients obtained from the regression:
Y = β0 + β1 log(X ) + U?
one percent change in X changes Y by β1/100 units
Lecture (1) Intro Metrics 09/02/2010 11 / 25
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Log-forms
How to interpret coe¢ cients obtained from the regression:
log (Y ) = β0 + β1X + U?
one unit of change in X changes Y by β1 � 100%
How to interpret coe¢ cients obtained from the regression:
Y = β0 + β1 log(X ) + U?
one percent change in X changes Y by β1/100 units
Lecture (1) Intro Metrics 09/02/2010 11 / 25
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R-square
What is the sum of squared total (SST) of the dependent variable Y ?
What is the sum of squared explained (SSE) of the regressionYi = β0 + β1Xi ?
What is the sum of squared residual (SSR) of that regression?
How much of the variation in Y is explained by the model?
R2 =??=1�?
?
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R-square
What is the sum of squared total (SST) of the dependent variable Y ?
What is the sum of squared explained (SSE) of the regressionYi = β0 + β1Xi ?
What is the sum of squared residual (SSR) of that regression?
How much of the variation in Y is explained by the model?
R2 =??=1�?
?
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R-square
What is the sum of squared total (SST) of the dependent variable Y ?
What is the sum of squared explained (SSE) of the regressionYi = β0 + β1Xi ?
What is the sum of squared residual (SSR) of that regression?
How much of the variation in Y is explained by the model?
R2 =??=1�?
?
Lecture (1) Intro Metrics 09/02/2010 12 / 25
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R-square
What is the sum of squared total (SST) of the dependent variable Y ?
What is the sum of squared explained (SSE) of the regressionYi = β0 + β1Xi ?
What is the sum of squared residual (SSR) of that regression?
How much of the variation in Y is explained by the model?
R2 =??=1�?
?
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Classical Linear Model Assumptions:
Assumption SLR.1 (Linear in Parameters) Y = β0 + β1X + U
Assumption SLR.2 (Random Sampling) (Xi ,Yi ), i = 1, ...,N, is arandom sample from the population.
Assumption SLR.3 (Sample Variation in the Explanatory Variable)fXi , i = 1, ...,Ng are not all the same value.
Assumption SLR.4 (Zero Conditional Mean) E (U jX ) = 0.
Assumption SLR.5 (Homoskedasticity) Var (U jX ) = σ2.
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Unbiasedness and Variance
What is unbiasedness?
we call the estimator β1 unbiased if E�
β1jX�=?
Under which assumptions unbiasedness hold?
Under all of the �ve assumptions,
Var�
β1jX�=?
What happens if there is no variation in X (SLR.3 is violated)?
What happens if there is heteroskedasticity (SLR.5 is violated)?
What does Gauss-Markov Theorem say?
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Omitted Variable Bias
When we do causal analysis, what is the interpretation for U?
If X and U are positively correlated, which assumption is violated?What happens to E
�β1jX
�now?
What is the e¤ect of omitting a variable that is independent of X?
What is the e¤ect of omitting a variable that has both direct positivee¤ect on Y and positive e¤ect on X?
What is the e¤ect of omitting a variable that has both direct negativee¤ect on Y and positive e¤ect on X?
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Multiple Regression
Y = β0 + β1X1 + ...+ βKXK + U
Estimated equation:
Yi = β0 + β1X1i + ...+ βKXKi
How are the OLS estimators β0, β1, ..., βK obtained?
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Unbiasedness and Variance
Under Assumptions MLR.1-4 (Linearity, Random Sampling, NoMulticollinearity, Conditional Mean-Zero):
E�
βj jX�=?
Under the above assumptions and MLR.5 (Homoskedasticity):
Var�
βj jX�=
σ2
SSTX�1� R2j
�What is σ2, SSTX or R2j ?
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What Variables to Include?
How does R2 change when we add more variables to the regression?
What�s the e¤ect on the unbiasedness of the estimators of includingirrelevant variables?
What�s the e¤ect on the unbiasedness of the estimators of omittingrelevant variables?
Are there any reasons for not including a particular variable on theleft hand side?
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What Variables to Include?
How does R2 change when we add more variables to the regression?
What�s the e¤ect on the unbiasedness of the estimators of includingirrelevant variables?
What�s the e¤ect on the unbiasedness of the estimators of omittingrelevant variables?
Are there any reasons for not including a particular variable on theleft hand side?
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What Variables to Include?
How does R2 change when we add more variables to the regression?
What�s the e¤ect on the unbiasedness of the estimators of includingirrelevant variables?
What�s the e¤ect on the unbiasedness of the estimators of omittingrelevant variables?
Are there any reasons for not including a particular variable on theleft hand side?
Lecture (1) Intro Metrics 09/02/2010 18 / 25
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What Variables to Include?
How does R2 change when we add more variables to the regression?
What�s the e¤ect on the unbiasedness of the estimators of includingirrelevant variables?
What�s the e¤ect on the unbiasedness of the estimators of omittingrelevant variables?
Are there any reasons for not including a particular variable on theleft hand side?
Lecture (1) Intro Metrics 09/02/2010 18 / 25
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Squares and Interactions
Y = β0 + β1X1 + β2X21 + ...+ U
What�s the partial e¤ect (marginal e¤ect) of X1 on Y ?
∂Y∂X1
=?
Y = β0 + β1X1 + β2X2 + β3X1X2 + ...+ U
What�s the partial e¤ect (marginal e¤ect) of X1 on Y ?
∂Y∂X1
=?
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Squares and Interactions
Y = β0 + β1X1 + β2X21 + ...+ U
What�s the partial e¤ect (marginal e¤ect) of X1 on Y ?
∂Y∂X1
=?
Y = β0 + β1X1 + β2X2 + β3X1X2 + ...+ U
What�s the partial e¤ect (marginal e¤ect) of X1 on Y ?
∂Y∂X1
=?
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Squares and Interactions
Y = β0 + β1X1 + β2X21 + ...+ U
What�s the partial e¤ect (marginal e¤ect) of X1 on Y ?
∂Y∂X1
=?
Y = β0 + β1X1 + β2X2 + β3X1X2 + ...+ U
What�s the partial e¤ect (marginal e¤ect) of X1 on Y ?
∂Y∂X1
=?
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Con�dence Interval
How is the t-statistic for βj formulated?
tn =βj�?
?
What�s the 95% con�dence interval of βj?hβj � 1.96�?, βj + 1.96�?
i
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Con�dence Interval
How is the t-statistic for βj formulated?
tn =βj�?
?
What�s the 95% con�dence interval of βj?hβj � 1.96�?, βj + 1.96�?
i
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Con�dence Interval
What is type I error of a test?
What is type II error of a test?
What is the signi�cance level of a test?
Suppose we are doing the two-sided test of H0 : βj = 0 vs. H1 :βj 6= 0.
If βj = 2, se(βj ) = 0.1, do we reject the null at 5% level?
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Con�dence Interval
What is type I error of a test?
What is type II error of a test?
What is the signi�cance level of a test?
Suppose we are doing the two-sided test of H0 : βj = 0 vs. H1 :βj 6= 0.
If βj = 2, se(βj ) = 0.1, do we reject the null at 5% level?
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Con�dence Interval
What is type I error of a test?
What is type II error of a test?
What is the signi�cance level of a test?
Suppose we are doing the two-sided test of H0 : βj = 0 vs. H1 :βj 6= 0.
If βj = 2, se(βj ) = 0.1, do we reject the null at 5% level?
Lecture (1) Intro Metrics 09/02/2010 21 / 25
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Con�dence Interval
What is type I error of a test?
What is type II error of a test?
What is the signi�cance level of a test?
Suppose we are doing the two-sided test of H0 : βj = 0 vs. H1 :βj 6= 0.
If βj = 2, se(βj ) = 0.1, do we reject the null at 5% level?
Lecture (1) Intro Metrics 09/02/2010 21 / 25
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Con�dence Interval
What is type I error of a test?
What is type II error of a test?
What is the signi�cance level of a test?
Suppose we are doing the two-sided test of H0 : βj = 0 vs. H1 :βj 6= 0.
If βj = 2, se(βj ) = 0.1, do we reject the null at 5% level?
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A Single Linear Combination of Parameters
How do we test:H0 : aβ1 + bβ2 = 0?
Modi�ed the regression:
Y = β0 + β1X1 + β2X2 + ...+ ε
= β0 + (aβ1)X1a+ (bβ2)
X2b+ ...+ ε
= β0 + (aβ1 + bβ2)X1a+ (bβ2)
�X2b� X1a
�+ ...+ ε
Run regression of Y on X1a and
X2b �
X1a .
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A Single Linear Combination of Parameters
How do we test:H0 : aβ1 + bβ2 = 0?
Modi�ed the regression:
Y = β0 + β1X1 + β2X2 + ...+ ε
= β0 + (aβ1)X1a+ (bβ2)
X2b+ ...+ ε
= β0 + (aβ1 + bβ2)X1a+ (bβ2)
�X2b� X1a
�+ ...+ ε
Run regression of Y on X1a and
X2b �
X1a .
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A Single Linear Combination of Parameters
How do we test:H0 : aβ1 + bβ2 = 0?
Modi�ed the regression:
Y = β0 + β1X1 + β2X2 + ...+ ε
= β0 + (aβ1)X1a+ (bβ2)
X2b+ ...+ ε
= β0 + (aβ1 + bβ2)X1a+ (bβ2)
�X2b� X1a
�+ ...+ ε
Run regression of Y on X1a and
X2b �
X1a .
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Multiple Hypotheses
How do we test:H0 : β1 = 0, β2 = 0?
Obtain SSR (SSRur ) from the unrestricted regression:
log (wage) = β0 + β1jc + β2univ + β3exper + ε
Obtain SSR (SSRr ) from the restricted regression:
log (wage) = β0 + β3exper + ε.
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Multiple Hypotheses
How do we test:H0 : β1 = 0, β2 = 0?
Obtain SSR (SSRur ) from the unrestricted regression:
log (wage) = β0 + β1jc + β2univ + β3exper + ε
Obtain SSR (SSRr ) from the restricted regression:
log (wage) = β0 + β3exper + ε.
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Multiple Hypotheses
How do we test:H0 : β1 = 0, β2 = 0?
Obtain SSR (SSRur ) from the unrestricted regression:
log (wage) = β0 + β1jc + β2univ + β3exper + ε
Obtain SSR (SSRr ) from the restricted regression:
log (wage) = β0 + β3exper + ε.
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Multiple Hypotheses
Form the F-statistic:
F � (SSRr � SSRur )/qSSRur/(n�K � 1)
� Fq,n�K�1.
What is q? What is Fq,n�K�1?
Reject H0 ifF > Fq,n�K�1,1�α
where α is the signi�cance level, Fq,n�K�1,1�α is the 1� α quantile ofFq,n�K�1
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Multiple Hypotheses
Form the F-statistic:
F � (SSRr � SSRur )/qSSRur/(n�K � 1)
� Fq,n�K�1.
What is q? What is Fq,n�K�1?
Reject H0 ifF > Fq,n�K�1,1�α
where α is the signi�cance level, Fq,n�K�1,1�α is the 1� α quantile ofFq,n�K�1
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Read the Table Reported by STATA
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