EXPERIMENT: Heteroscedasticity and Multicollinearity This experiment involves the problems o multicollinearity and heteroscedasticity!

The data or the experiment are rom the 1"#$ %ensus and include observations or each o the &$ states on total primary and secondary educational expenditures and related explanatory variables! Total expenditures on education are assumed to depend positively on total population' personal income' and the si(e o the population belo) 1* years o a+e! The positive relationship bet)een these variables and total expenditures re lects the demand or public expenditures! In addition' actors that in luence a population,s pre erences or education )ill shi t the demand schedule! -uch pre erences are proxied in this experiment by the educational attainment o the adult population and the extent to )hich the population resides in urban areas! .oth actors are expected to increase pre erences or education! Historically' researchers have also included a race variable /e!+! si(e o non0)hite population1! The results have been mixed )ith some researchers indin+ a positive in luence o race on expenditures and others indin+ a ne+ative impact! T)o orms o the educational expenditure e2uations )ill be implemented: a total expenditure orm and a per capita orm! Total population derives the per capita orm rom the 3total4 orm by dividin+ all variables in the model' except educational attainment' by population! The pre erence or a per capita orm on theoretical +rounds is that it is a closer approximation to individual behavior! 5iven the microeconomic orientation o the model speci ication' the measurement o a++re+ate behavior is less appropriate! The per capita orm also is pre erred on statistical +rounds i there is multicollinearity in the a++re+ate data! Multicollinearity could arise in this experiment since the lar+er the population o a state the lar+er its personal income' population under 1*' and urban population! %onse2uently all o these explanatory variables )ould be correlated su iciently to create a multicollinearity problem! .y creatin+ per capita data' the common scale actor o population )ould be removed thereby probably reducin+ the multicollinearity problem! The problem o heteroscedasticity could also arise in this type o cross section data set in either the total expenditure or per capita expenditure orms! In the ormer case the variability o public expenditures and hence the variance o the

e2uation errors is li7ely to increase )ith the scale actor /population1! In the per capita orm hi+her levels o per capita income imply a +reater de+ree o discretion over usa+e o income and hence +reater variability in public expenditure levels! In this experiment you )ill test or heteroscedasticity in the per capita model usin+ the 8hite test! This is a test a+ainst heteroscedasticity o a very +eneral orm! In the 8hite test the s2uared residuals are re+ressed on all o the independent variables' their s2uares' and /optionally1 their cross products! I heteroscedasticity is present' $9- leads to ine icient estimates o the coe icients and biased standard errors' )hich invalidates hypothesis testin+' re2uirin+ an alternative estimation procedure! :ne option is 8hite;s correction' )hich only treats the problem o biased standard errors' 7eepin+ the ine icient least s2uares estimates o the coe icients! The advanta+e o this option is that it does not re2uire that you identi y the precise orm o heteroscedasticity that exists in the model! <n alternative is to use )ei+hted least s2uares /89-1' )hich is a special case o 5enerali(ed 9east -2uares /59-1! This approach re2uires that you can identi y the precise orm o the heteroscedasticity that pla+ues your model! =or example' i you suspect that the error variance is positively related to the s2uare o some variable' >' then you )ould divide every observation o the ori+inal model by >! I your assumption is correct' this )ill pur+e the e2uation o heteroscedasticity' producin+ e icient estimators )ith unbiased standard errors! The )ei+ht' in this example' is the reciprocal o >' and Evie)s re2uires that you +enerate this reciprocal be ore invo7in+ the )ei+hted least s2uares option! Implementation Data Entry =i ty observations are available in the htm ile ormat or the variables %:?E EXPEN? P:P P@ P:P91* P:PAR. ME?E? P:PN8 /in that order1' )here: %:?E B state code number EXPEN? B total primary and secondary educational expenditures per -tate /thousands o dollars1 P:P B total -tate population

P@ B total -tate personal P:P91* B -tate population P:PAR. B -tate population ME?E? B median years o adult population /years1 P:PN8 B -tate,s non0)hite

income /millions o dollars1 under 1* years o a+e residin+ in urban areas school completed amon+ -tate,s population

@ou should copy the data to your dis7ette in the usual manner! Then create a ne) )or7 ile or &$ undated observations' and read the data into this )or7 ile! The data are or+ani(ed by observation' not in rectan+ular orm' )ith spaces as /possibly multiple1 delimiters! To con irm that the data have been read correctly' the second observations on the variables in the order +iven above are
6 6D"1"& 1"6C6D$ &C"C!& E&*&*E "E6D&E 1$!& C&E"#E

Estimation and Testing 1! ?o an $9- re+ression usin+ the total expenditure variable list or the e2uation dialo+ box is EXPEN? % P:P P@ P:P91* P:PAR. ME?E? P:PN8 Print the output! 6! To chec7 or multicollinearity' obtain a correlation matrix or the re+ressors! The correlation matrix is accessed rom the main Evie)s toolbar' choosin+ 2uic7F5roup statisticsF correlations! The variable list should include all re+ressors: P:P P@ P:P91* P:PAR. ME?E? P:PN8 Print the result. C! 5enerate the per capita variables and per orm an :9re+ression on the model +iven above but usin+ the per capita data you must +enerate! /?o not trans orm ME?E? into per capita orm' and omit P:P rom the re+ression! =or example' i the su ix P indicates a per capita variable' the variable list or the e2uation dialo+ box should be EXPEN?P % P@P P:P91*P P:PAR.P ME?E? P:PN8P .e ore closin+ the e2uation )indo)' save the e2uation by +ivin+ orm! The

it a name' )hich you can do by selectin+ 3name4 rom the e2uation toolbar' and then typin+ a name in the dialo+ box! Print the regression output. D! No) examine the correlation matrix or this +roup o re+ressors! The variable list should include: P@P P:P91*P P:PAR.P ME?E? P:PN8P Print the result. %all up the e2uation that you saved at step D by double0clic7in+ on the name you +ave it at step D! @ou )ill ind this e2uation listed )ith all your other 3obGects4 in the 8or7 ile )indo)! The ollo)in+ procedures can be per ormed by repeatedly returnin+ to the )indo) or this e2uation! &! Test the residuals or normality! /=rom the e2uation )indo) select Hie)FResidual testsFHisto+ram!1 Note the value of the Jarque-Bera Statistic and its p-value. E! Per orm the 8hite test or +eneral herteroscedasticity' by choosin+ Hie)FResidual testsF8hite heteroscedasticity: no cross terms! This option excludes the cross products o the independent variables rom the 8hite test e2uation! Print the result, which will include the White test equation! #! No) re0estimate the per capita expenditures re+ression usin+ the 8hite correction! To do this' clic7 on 3estimate4 rom the e2uation toolbar' and your ori+inal variable list should appear! No) rom this dialo+ box select :ptions' then enter a chec7 in the box or heteroscedasticity and or 8hite! Then clic7 :I t)ice' and the 8hite procedure )ill be implemented! Print the result! *! 8ei+hted least s2uares! Jud+in+ rom the 8hite test e2uation' P:P91*P appears to be the most important source o heteroscedasticity' so you )ill use the reciprocal o this variable as the )ei+hts in this procedure! -)itch to the 8or7 ile 8indo) /)ithout closin+ the E2uation )indo)1 and +enerate P1*P1 as 1!$FP:P91*P! Then s)itch bac7 to the e2uation )indo)' and choose the estimate option a+ain! @our per capita e2uation speci ication should appear a+ain! No) select :ptions' and remove the chec7 rom the heteroscedasticity box' and chec7 the )ei+hted 9- box! Then type in the variable that is used to

)ei+ht the observations /P1*P1 in my example1! Hit :I t)ice and the 89- results are produced! Print the result!

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Exercises 1! %ompare the R0s2uared and t0statistics rom the total expenditure and per capita orms! /Note that the hi+her R0 s2uared is not the most important criterion in this evaluation! 8hyK1 6! .ased on the simple correlation coe icients matrix' is multicollinearity a problem in the total expenditure ormK ?oes the per capita approach deal )ith the problemK 8hat is your evidenceK

C! Report the results o the t)o dia+nostic tests per ormed on the per capita re+ression! In particular' are the residuals normalK Justi y! ?oes the 8hite test indicate heteroscedasticityK =rom the 8hite test e2uation' )hat variable do you suspect as bein+ the LsourceL o heteroscedasticityK Explain! D! %ompare the 8hite0corrected standard errors )ith those rom the :9- re+ression! 8hat does this su++est about the +eneral direction o the bias o the :9- standard errors in the presence o heteroscedasticityK ?id any coe icient lose statistical si+ni icanceK 8hy are the coe icient estimates rom the :9- and the 8hite procedure identicalK &! %ompare :9- and 89- results! ?id any coe si+ni icance )ith the use o 89-K icient lose

E! In )hich o the three re+ressions )ould you place the most con idenceK 8hyK Is there any additional testin+ you )ould do be ore ma7in+ this Gud+ment /limitin+ your concerns to the problem o heteroscedasticity1K