CITY UNIVERSITY OF SCIENCE AND INFORMATION

TECHNOLOGY, PESHAWAR
Submitted by: UMAIR AHMED

ID No: 7029

Subject: Econometrics

Subject Teacher: Prof. Dr. Anwar Fazil Chishti

Assignment No: 1 (Part-II)

Assignment Type: Major

Submission Date: 22/02/2016

1ST Submission

Assignment Topic: TESTING FOR ECONOMIC PROBLEM AND THEIR REMEDIES.

a) TESTING FOR MULTICOLLINEARITY AND ITS REMEDIES

TESTING OF MULTICOLLINEARITY
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Lets try to understand the nature of the perfect collinear and less-thanperfect collinear explanatory variables. Data on JS and four intended
explanatory variables, namely DJ, PJ, IJ and INJ
Model Summary
Model

.477

R Square

Adjusted R

Std. Error of the

Square

Estimate

.228

.175

.52299

a. Predictors: (Constant), AEE, Procedural justice, Interactive justice ,

Informational justice, Distributive justice

ANOVAa
Model

Sum of Squares
Regression

df

Mean Square

5.965

1.193

Residual

20.240

74

.274

Total

26.205

79

Sig.
.002b

4.362

a. Dependent Variable: Job satisfaction

b. Predictors: (Constant), AEE, Procedural justice, Interactive justice , Informational justice,
Distributive justice

Coefficientsa
Model

Unstandardized

Standardized

Coefficients

Coefficients

B
(Constant)

3.820

.502

Distributive justice

.003

.072

Procedural justice

-.003

Interactive justice
Informational justice
AEE

a.

Std. Error

Sig.

Beta

Collinearity Statistics

Tolerance

VIF

7.611

.000

.005

.037

.971

.531

1.884

.069

-.006

-.044

.965

.493

2.028

-.064

.086

-.082

-.750

.456

.866

1.155

.364

.100

.459

3.620

.001

.650

1.539

-.013

.005

-.268

-2.532

.013

.930

1.076

Dependent Variable: Job satisfaction

EVALUATION OF MULTICOLINEARITY
TOL:
As empirical results suggesting that the explanatory variable PJ has a lower degree of
Tolerance and high Multicolinearity of that explanatory variable with other explanatory
variables. TOL of PJ is 0.493 which is closer to TOL 0.While DJ, IJ, INJ and AEE having
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high tolerance level and low multicollinearity. These variables have that TOL values,
DJ:0.531, IJ:0.866, INJ:0.650 and AEE:0.930 which is closer to TOL 1.
VIF:
The explanatory variable PJ having high multicollinearity i.e. VIF 2.028, DJ having also high
multicollinearity at VIF 1.884, INJ having high multicollinearity because VIF 1.539, IJ and
AEE have low multicollinearity as compare to other explanatory variables which is 1.115 &
1.076 respectively.

REMEDIES OF MULTICOLLINEARITY
The perfect correlation between Xs are rarely exists but light correlation
problem occurred mostly. Multicollinearity problem is exists in model due
to strong (High) correlation between Xs.
1: Do nothing
Being an Econometrics student, one solution is that to do nothing. i.e.
doesnt interfere in model. This remedies are adopted by many
Econometricians (i.e Koutsoyiannis, Gujrati etc)
2: Increase the sample size (n)
By increasing the number of observation, this problem either totally
solved or minimized, Hence increasing the sample size is a comparatively
a good solution for removal of multicollinearity.
3: Dropping an variable
By dropping one variable (which is not more important for study) which is
multi-collinear, this problem can be solved. E.g. The consumption function
in case of wealth (X1) and Income (X2).
Yi = 0+1X1+2X2+ei
Here X1 is not an important variable as Income X2. So by dropping
X2 variable from model, the problem will be removed.
Yi = 0+1X+ei (New Model)
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4: Taking log of variable

By taking log of data, the correlation between Xs can be removed or
minimized because log make data more minimum.
E.g: log Y = 0+1logX1+2logX2+ei
5: Ratio transformation
One solution of removal of strong correlation between Xs by dividing
whole model by an explanatory variable.
E.g: Yi = 0+1X1+2X2+ei --------- (A)
Where, Y= Consumption
X1= Population
X2= Net Income
Dividing equation (A) by X
Yi/x = 0/x+1X1/x+2X2/x+ei/x
Yi = 0+1X1+2X2+ei ---------- (B)
Where, Yi = Per Person Consumption
X1 = Reciprocal of Population
X2 = Per Capita Income
6: Taking differences
By taking differences the problem of multi collinearity can be removed.
E.g: Let Yt = 0+1X1t+2X2t+eit --------- (A)
The 1st difference of the above model will be,
Yt-1 = 0+1X1t-1+2X2t-1+eit-1 -------- (B)
By taking difference of (A) and (B)
Yt-Yt-1 = 0+1(X1t-X1t-1)+2(X2t-X2t-1)+eit-et-1
Yt = 0+1X1t+2X2t+et
This is our new regression model.

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