Slides 01

Advanced Econometrics I
Ingo Steinke, Anne Leucht, Enno Mammen

University of Mannheim
Fall 2014
Ingo Steinke (Uni Mannheim)
Fall 2014
Organisation
Important dates
Start: 2013-10-07
End: 2013-12-05
Lectures:
Tuesday 10:15 - 11:45 in L 7, 3-5 - 001
Thursday 10:15 - 11:45 in L 7, 3-5 - 001
Exercises:
Thursday 13:45 - 15:15 in L 9, 1-2 003
Thursday 15:30 - 17:00 in L 9, 1-2 003
teaching assistants: Maria Marchenko
Slides will be provided via Ilias, usually on Friday for the next week.
Fall 2014
Exercise sheets
will be provided via Ilias and usually published on Tuesday (or
Wednesday).
hand in written solutions in lecture on Tuesday (you may work in
pairs).
discussion of the solutions on Thursday.
There is 1 point per exercise (0.25,0.5,0.75,1).
You need 75% of the points of the Exercise sheet to get (at most)
20% of the exam points.
There will be stared exercises which can be used to make up for
missing points of one exercise sheet.
Fall 2014
Exam
written exam, 180 min
Date: 2014-12-17
Contact
Office: L7, 3 - 5, room 142
Phone: 1940
E-Mail: isteinke@rumms.uni-mannheim.de
Office hour: on appointment
Fall 2014
Contents
Overview:
1
Probability theory
Asymptotic theory
Conditional expectations
Linear regression
Fall 2014
Literature
Ash, R. B. and Doleans-Dade, C. (1999). Probability & Measure
Theory. Academic Press.
Billingsley, P. (1994). Probability and Measure. Wiley.
Hayashi, F. (2009). Econometrics. Princeton University Press.
Jacod, J. and Protter, P. (2000). Probability Essentials. Springer.
Van der Vaart, A. W. and Wellner, J. A. (2000). Weak Convergence
and Empirical Processes. With Applications to Statistics. New York:
Springer.
Wooldridge, J. M. (2004). Introductory Econometrics: A Modern
Approach. Thomson/Southwestern.
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Introduction
Motivation
Application in Statistics ...

Study relationship between variables, e.g.
consumption and income
How does raising income effect consumption behaviour?
evaluation of effectiveness of job market training (treatment effects)
...
Econometrics (Wooldridge (2004)):

development of statistical methods for estimating economic
relationships
testing economic theories
evaluation of government and business policies
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Classical model in econometrics: linear regression
Figure: http://en.wikipedia.org/wiki/File:Linear regression.svg
Y = 0 + 1 X + u,
e.g. Y consumption, X wage, u error term typically data not generated by
experiments, error term collects all other effects on consumption besides
wage
variables somehow random
How do we formalize randomness?
Fall 2014
Aims of this course:

(1) Provide basic probabilistic framework and statistical tools for
econometric theory.
(2) Application of these tools to the classical multiple linear regression
model.
Application of these results to economic problems in Advanced
Econometrics II/III and follow-up elective courses.
Fall 2014
Chapter 1: Probability theory
Chapter 1: Elementary probability theory

Overview
Probability measures
Probability measures on R
Random variables
Expectation
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1.1 Probability measures

Aim: Formal description of probability measures
Setup:
The set 6= of the possible outcomes of an random experiment is
called sample space, e.g. = N = {1, 2, }.
A event, e.g. A = {2, 4, 6, 8, }
outcome:
Want to assign a probability P(A) to event A
Consider first the case that is a countable set, i.e.
= {1 , 2 , 3 , }
(e.g. = N, = Z).
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11
= { } denotes the empty set,

P() = {A : A } the power set.
Defintion 1.1
A probability measure P on a countable set is a set function that
maps subsets of to [0, 1], i.e. P : P() [0, 1], and has the following
properties:
(i) P() = 1.
(ii) It holds
P(
[
i=1
Ai ) =
P(Ai )
i=1
for any Ai , i N, that are pairwise disjoint, i.e Ai Aj = for

i 6= j.
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Recap: Index notation

Let I 6= some set and Ai for all i I . Then
[
x
Ai j I : x Aj .
iI
If I = {1, . . . , n} and J = N, then

[
Ai = A1 An =
Ai ,
i=1
iI
n
[
Aj = A1 An =
Aj .
j=1
jJ
Especially, for I = A and Ax = {x},

A=
{x}.
xA
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13
Recap: Series
A set is countable iff there is a set N N and a bijection
(one-to-one-map) m : N A. Then A can be written A = {a1 , a2 , . . . , an }
or A = {a1 , a2 , . . . , an , . . . }.
A series is a infinite sum and defined by
s=
ak = lim
k=1
n
X
ai
k=1
if the limit exists. The series s is absolutely convergent if
|ak | < .
k=1
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The series s is unconditionally well-defined

if for any
P
{k1 , k2 , k3 , . . . } = N we have s = i=1 aki , i.e. a rearrangement of its
members does not change the (infinite) sum which might be oder .
Note:
If a series is absolutely convergent, then it is unconditionally
convergent.
A series is unconditionally well-defined iff the (infinite) sums of all its
positive members or the sum of all negative members is finite.
Let I be countable and ai R for any i I . If I = {i1 , i2 , . . . }, then
X
iI
ai :=
aij ,
j=1
if the right-hand series is unconditionally convergent
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Lemma 1.2
For a countable sample space = {i }iI (with countable I ) and a
probability measure P on . Then for every A , it holds
X
P(A) =
P({}).
A
Proof: Exercise.
Let . An event {} that only contains one element is also called an
elementary event.
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Arbitrary sample spaces
It is often impossible to define P appropriately for all subsets A

such that Definition 1.1 holds true; see e.g. Billingsley (1994).
Definition 1.3 A family A of subsets of with
(i) A,
(ii) if A A, then AC = \A A,
S
(iii) if A1 , A2 , A, then
i=1 Ai A,
is called a -field or -algebra.
For a -field A of holds: A P().
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A -field A is called smallest--field, containing B P(), if for any

-field C of holds: If B C, then A C.
Notation: A = (B).
Example 1.4 Let 6= be a set.
{, } is the smallest -field on and is called trivial -field.
The power set P() is the largest -field on .
If =
6 B , the family {, , B, B C } is the smallest -field on
that contains B.
Suppose that A is a -field on a set . Then the tuple (, A) is called a
measurable space.
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Definition 1.5
A set function P : A [0, ) is a measure on (, A) if for A1 , A2 , . . .
pairwise disjoint A it holds that
!
[
X
P
Ai =
P(Ai )
( additivity)
i=1
i=1
If, in addition, P() = 1, then it is called probability measure.

The triple (, A, P) is then called a probability space.
Example 1.6 Let (, A) be a measurable space and 0 .
Then (A) = |A|, A A, is the so-called counting measure.
The Dirac measure 0 is then defined by
0 (A) := 1A (0 )
A A.
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Theorem 1.7 (Properties of probability measures)

Suppose that (, A, P) is probability space. Let A, B, A1 , A2 , A.
Then holds:
(i) P() = 0
(ii) Finite additivity: A1 , . . . , An pairwise disjoint imply
P(
n
[
i=1
Ai ) =
n
X
P(Ai ).
i=1
(iii) P(AC ) = 1 P(A).

(iv) P(A) 1 for all A A.
(v) Subtractivity: A B implies P(B\A) = P(B) P(A).
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(vi) Monotonicity: A B implies P(A) P(B).

(vii) P(A B) = P(A) + P(B) P(A B).
(viii) Continuity from below: An An+1 for all n N implies
S
P(An ) P(
Ak ).
n
k=1
(ix) Continuity from above: An+1 An for all n N implies
T
Ak ).
P(An ) P(
n
k=1
(x) Sub--additivity: P(
An )
n=1
P(An ).
n=1
Proof: Exercise.
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1.2 Probability measures on R

Definition 1.8 The smallest -field B, that contains all open intervals
(a, b) ( a b ), is called the Borel -field.
A set A B is called a Borel set.
Theorem 1.9 Put
A1 = {(a, b] : a < b < +},
A2 = {[a, b) : < a < b +},
A3 = {[a, b] : < a b < +},
A4 = {(, b] : < b < +}.
Then it follows for j = 1, . . . , 4: B = (Aj ).
Proof: Exercise.
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Definition 1.10
A class A of subsets of is a field if
(i) A ,
(ii) A A , then AC A ,
(iii) A1 , A2 A , then A1 A2 A .
Suppose that A is a field and define A as the smallest -field with
A A (notion: A = (A )). Then a set S
function P : A [0, ) s.t.
for A1 , A2 , . . . pairwise disjoint A with

i=1 Ai A it holds that
!
[
X
P (Ai )
P
Ai =
i=1
i=1
is called pre-measure.
If, in addition, P () = 1 it is called probability pre-measure.
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Theorem 1.11 (Caratheodory) Let A be a field, A = (A ) and P

a probability pre-measure on A . Then there exists a unique
probability measure P on A with
P(A) = P (A) for A A .
For a proof see Ash and Doleans-Dade (1999), Theorem 1.3.10.

Definition 1.12 For a probability measure P on (R, B) the function
F : R [0, 1] given by
F (b) = P((, b])
b R
is called a (cumulative) distribution function (CDF).

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Proposition 1.13 (Properties of the CDF) Suppose that F is the

distribution function of a probability measure P on (R, B). Then
(i) P((a, b]) = F (b) F (a) for a < b,
(ii) F is non-decreasing (i.e. F (a) F (b) for a b),
(iii) F is continuous from the right (i.e. F (bn ) F (b) for bn b,
bn b (or for bn b)),
(iv) limx F (x) = 0 and limx+ F (x) = 1.
(v) F (b) := limn F (bn ) = P((, b)) for any bn b.
(vi) P({b}) = F (b) F (b) for all b R.
Define P by F on A1 : P((a, b]) = F (b) F (a), a < b.
Can this function be uniquely extended to a set function on B?
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Theorem 1.14 Consider a function F : R R satisfying (ii) to (iv) of

Proposition 1.13. Then F is a distribution function (i.e. then there
exists a unique probability measure P on (R, B) with
F (b) = P((, b]) for all b R).
Some ideas of the proof: First, define a set function P : A1 [0, 1] as
P ((a, b]) = F (b) F (a).
Extend this function as follows: P : A [0, 1], where A consists of the
empty set and all finite unions of sets of A1 and their complements, and
for disjoint intervals
!
n
n
[
X
P
(ai , bi ] =
P ((ai , bi ]) with notation (c, ] = (c, ).
i=1
i=1
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Discrete probability measures

The function f : R R is called probability mass function (pmf) if
1
2
f (x) 0 for all x R and

P
it holds xSf f (x) = 1 with Sf = {x R : f (x) > 0}.
Note that Sf must be countable if 2. holds. Sf is called support of f .

Define
X
P(A) =
f (x).
(1)
xSf A
Lemma 1.15 P, defined by (1), is a probability measure.

Then, the cdf is defined by F (x) =
aSf (,x] f (a).
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Definition 1.16 A probability measure P on the measurable space (R, B)

is discrete if there is an at most countable set A R such that P(A) = 1.
By
SP = {a R : P({a}) > 0}
we denote the support of a discrete probability measure R.
Lemma 1.17 P is discrete iff f : R R, f (x) = P({x}), is a pmf.

Remark 1.18
1
SP A is countable and P(SP ) = 1.
If P is a discrete probability measure with support SP then F has

jumps at a SP with jump heights P({a}).
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Example 1.19
1
Binomial distribution

n i
P({i}) =
(1 )(ni) for i = 0, 1, . . . , n,
i
P({i}) = 0 elsewhere. Parameter: 0 1, n 1.
Geometric distribution
P({i}) = (1 )i1 for i = 1, 2, 3 . . .
P({i}) = 0 elsewhere. Parameter: 0 1.
Poisson distribution
P({i}) =
i
e , i = 0, 1, 2, . . .
i!
P({i}) = 0 elsewhere. Parameter: > 0.

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Absolultely continuous probability measures

A (Riemann) integrable function f : R R is called probability density
function (pdf) if
1 f (x) 0 for all x and
R
2
f (x)dx = 1.
In the following we assume that f is piecewise continuous, i.e. the is an
at most
S countable index set I and pairwise disjoint open intervals Ai R
with iI Ai = R such that
f (x) is continuous on Ai for all i I .
Lemma 1.20 Let f : R R be a piecewise continuous pdf. Then
there exists a unique probability measure on (R, B) such that
Z
P((a, b]) =
f (x)dx,
for all a < b.
a
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The corresponding distribution P isR called absolutely continuous.

x
Then the CDF is given by F (x) = f (t)dt.
Note that F is continuous and
F 0 (x) = f (x),
if f is continuous at x.
A density is not unique but almost unique.
Lemma 1.21 Let f , g be piecewise continuous pdfs such that
Z
Z
f (x)dx =
g (x)dx
for all a < b.
Then {x : f (x) 6= g (x)} is countable.
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Example 1.22
1
Normal distribution

1
1 (x )2
f (x) =
exp
.
2 2
2
Parameter: R, > 0
Uniform distribution
f (x) =
1
1 (x)
b a [a,b]
Parameters: < a < b <

3
Exponential distribution
f (x) = e x 1[0,) (x)
Parameter: > 0
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Extension to Rk
The Borel -field B k is the -field generated by the open intervals
(a1 , b1 ) (ak , bk ). As in the real-valued case, probability measures on
(Rk , B k ) are uniquely defined via the multivariate distribution function:
F (b1 , . . . , bk ) = P({(x1 , . . . , xk ) : x1 b1 , . . . , xk bk }).
F is called absolutely continuous if:
Z
b1
bk
F (b1 , . . . , bk ) =
f (x1 , . . . , xk )dxk dx1
for all b1 , ..., bk R. Here, if f continuous at (x1 , . . . , xk ), then

k F
(x1 , . . . , xk ) = f (x1 , . . . , xk ).
x1 xk
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The Borel -field B k is the -field generated by the open intervals

(a1 , b1 ) (ak , bk ).
The function f : Rk R is called (multivariate) probability mass
function if
1
2
f (x) 0 for all x Rk and

P
it holds xSf f (x) = 1 with Sf = {x Rk : f (x) > 0}.
Define the discrete probability measure on (Rk , B k ) by

X
P(A) =
f (x),
xSf A
cf.(1), p.27.
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A (Riemann) integrable function f : Rk R is called (multivariate)

probability density function if
1
f (x) 0 for all x and
it holds
Z
f (x)dx :=
Rk
f (x1 , . . . , xk )dxk dx1 = 1.
Then by
Z
b1
P((a1 , b1 ] (ak , bk ]) =
bk
a1
f (x1 , . . . , xk )dxk dx1

ak
a probability measure can be introduced on (Rk , B k ) which is called

absolutely continuous.
Fall 2014
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Advanced Econometrics I

Ingo Steinke, Anne Leucht, Enno Mammen

Ingo Steinke (Uni Mannheim)

Ingo Steinke (Uni Mannheim)

Ingo Steinke (Uni Mannheim)

Ingo Steinke (Uni Mannheim)

Ingo Steinke (Uni Mannheim)

Ingo Steinke (Uni Mannheim)

Application in Statistics ...

Econometrics (Wooldridge (2004)):

Ingo Steinke (Uni Mannheim)

Classical model in econometrics: linear regression

Figure: http://en.wikipedia.org/wiki/File:Linear regression.svg

Aims of this course:

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

Chapter 1: Elementary probability theory

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

1.1 Probability measures

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

= { } denotes the empty set,

for any Ai , i N, that are pairwise disjoint, i.e Ai Aj = for

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

Recap: Index notation

If I = {1, . . . , n} and J = N, then

Especially, for I = A and Ax = {x},

Chapter 1: Probability theory

1.1 Probability measures

if the limit exists. The series s is absolutely convergent if

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

The series s is unconditionally well-defined

if the right-hand series is unconditionally convergent

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

Arbitrary sample spaces

It is often impossible to define P appropriately for all subsets A

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

A -field A is called smallest--field, containing B P(), if for any

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

If, in addition, P() = 1, then it is called probability measure.

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures

Theorem 1.7 (Properties of probability measures)

(iii) P(AC ) = 1 P(A).

Ingo Steinke (Uni Mannheim)

Chapter 1: Probability theory

1.1 Probability measures