EC3304

Econometrics II
Semester 1, 2016-2017
Tutorial #4
You will receive full credit if you present your attempt at the solution during
tutorial, whether or not you have the correct answer. Also, feel free to discuss
the questions and answers with other students who have not yet attended
tutorial. However, I request that you do not ask former students of this
module or current students who attend an earlier tutorial than you for the
answers before your own tutorial has taken place.
1. (Final Exam, Sem 2, 2014-15) A spurious regression of Y on X refers to
a regression for which
(a) Y is I (1), X is I (1), and the regression error is I (0).
(b) Y is I (1), X is I (1), and the regression error is I (1).
(c) the correlation coefficient cannot be estimated.
(d) the TSLS estimates are very different from the OLS estimates.
(e) both Y and X are I (0).
2. (Final Exam, Sem 1, 2014-15) Two series are said to be cointegrated if
(a) both series are I (1) but a linear combination of them is I (0).
(b) both series are I (0) but a linear combination of them is I (1).
(c) both series have the same set of explanatory variables but a different
dependent variable.
(d) both series have the same dependent variable but a different set of
explanatory variables.
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3. (Final Exam, Sem 2, 2015-16) Consider the following time series process:

+ ut
if t k
Yt =
+ + u if t > k
t

where and are non-zero constants and ut i.i.d. 0, 2 . This process
is
(a) non-stationary
(b) a random walk
(c) trend stationary
(d) stationary
(e) none of the above
4. (Final Exam, Sem 1, 2015-16) Consider the following model:
yt = 0 + 1 t + ut ,


where ut i.i.d. 0, 2 .
(a) Transform the model to a model in first differences.
(b) Find an estimator of 1 in the model in first differences.
(c) Is the estimator you found in part (b) unbiased? Show why or why
not.
(d) Is the estimator you found in part (b) consistent? Show why or why
not.

(e) Is the error of the model in first differences weakly dependent? Show
why or why not.
5. The goal of this question is to estimate how an increase in the price
of oil affects the price of petrol. Use the dataset petrol uploaded to
IVLE to answer this question. This dataset contains data on average
monthly petrol price (price) in Singapore from 2000 to 2010, the oil cost
of producing one litre of petrol (cost), and the CPI.
(a) Deflate price and cost by CPI. Call the new variables rprice and
rcost.
(b) Plot and compute the sample autocorrelations of rprice and rcost.
(You can use the tsline and corrgram if you are using Stata.) Is
there evidence of a unit root?
(c) Test if rprice or rcost have a unit root.
(d) Estimate the regression
pricet = + costt + zt ,
and test for co-integration. Critical values are contained in table 16.2
of Stock and Watson.
(e) Estimate by DOLS by estimating:
rpricet = 0 + rcostt +

1
X
j=1

Explain.
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j rcosttj + ut

6. This question uses a type of panel data called independently pooled

cross sections, or pooled data for short. Pooled data is obtained
by randomly sampling from a population at different points in time (as
opposed to collecting data from the same entity at two different times).
Pooled data is often useful in evaluating the impact of a certain event or
policy as this question shows.
Use the dataset KIELMC uploaded to IVLE to answer this question. Kiel
and McClain (1995) studied the effect that a new garbage incinerator had
on house values in North Andover, Massachusetts. In the question, we
will estimate a similar but simplified version of their model with two
years of data.
Construction of the new incinerator began in 1981. The hypothesis is that
construction of the incinerator would cause the price of houses located
near the incinerator to fall relative to the price of more distant houses.
We will use data on prices of houses sold in 1978 and in 1981 to test this.
A house is defined to be near the incinerator if it is within three miles.
The variable nearinc = 1 if a house is near the incinerator and 0 if not.
Housing prices rprice are in real 1978 dollars.
(a) A naive analysis might only use the 1981 data. Estimate the following
model using 1981 data and interpret your results.
rprice = 0 + 1 nearinc + u.
Unfortunately, the regression in part (a) does not necessarily show whether
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the incinerator caused lower house price.

(b) Re-estimate the model in part (b) using 1978 data, and interpret the
results.
The results in part (a) and (b) suggest we have not yet estimated the
effect on prices (why?). So how can we tell whether the incinerator
depressed prices? The key is to look at how the coefficient on nearinc
changed between 1978 and 1981.
(c) Compute the difference in the two coefficients as:
1 = 1,81 1,78

(1)

This estimate is known as the difference-in-differences estimator .

It estimates the effect of some event or policy change by comparing the
change in the outcomes of the group affected by the event (the treatment
group) to the change in the outcomes of another group that is not affected
(the control group). This can be more easily seen with a more intuitive
representation of the estimator:




1 = rprice81,near rprice81,f ar rprice78,near rprice78,f ar

(2)

Although we now have an estimate of the effect, we still need to find the
standard error. The easiest way to do so is to note that equation (1)
comes from the following model:
rprice = 0 + 0 y81 + 1 nearinc + 1 y81 nearinc + u.
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Here, y81 is a dummy variable that equals 1 if the observation is from

1981 and 0 if it not.
(d) Estimate the model and interpret all the coefficients.
Kiel and McClain included various housing characteristics in their analysis. There are two good reasons to do so. First, the kind of houses sold
in 1981 may have been systematically different than those sold in 1978
and it is important to control for this. But just as important, including
more relevant variables can greatly reduce the error variance which can
shrink the standard error of 1 . The model becomes:
rprice = 0 + 0 y81 + 1 nearinc + 1 y81 nearinc + X 0 + u,

(3)

where X is a vector of housing characteristics.

(e) Estimate (3) including controls for distance to the interstate (intst),
land area in feet (land), house area in feet (area), number of rooms
(rooms), number of baths (baths), age of the house (age), and age
squared. How does the estimate of 1 and its standard error change?