Chapter 6

Extensions of the Two-Variable Linear Regression Model

6-1. Regression through the origin

The SRF form of regression:

Yi = b^2X i + u^ i (6.1.5)

Comparison two types of regressions:

Regression through-origin model and

Regression with intercept

6-1. Regression through the origin

Comparison two types of regressions:

b^2 = SXiYi/SX2i (6.1.6) O

b^2 = Sxiyi/Sx2i (3.1.6) I

var(b^2) = s2/ SX2i (6.1.7) O

var(b^2) = s2/ Sx2i (3.3.1) I

s^2 = S(u^i)2/(n-1) (6.1.8) O

s^2 = S(u^i)2/(n-2) (3.3.5) I

6-1. Regression through the origin

r2 for regression through-origin model

Raw r2 = (SXiYi)2 /SX2i SY2i (6.1.9)

Note: Without very strong a priory expectation, well advise is sticking to the
conventional, intercept-present model. If intercept equals to zero statistically, for
practical purposes we have a regression through the origin. If in fact there is an
intercept in the model but we insist on fitting a regression through the origin, we
would be committing a specification error

6-1. Regression through the origin

Capital Asset Pricing Model - CAPM

Market Model

The Characteristic Line of Portfolio Theory

6-2. Scaling and units of measurement

Let Yi = b^1 + b^2Xi + u^ i (6.2.1)

Define Y*i=w 1 Y i and X*i=w 2 X i then:

b*^2 = (w1/w2) b^2 (6.2.15)

b*^1 = w1b^1 (6.2.16)

s*^2 = w12s^2 (6.2.17)

Var(b*^1) = w21 Var(b^1) (6.2.18)

Var(b*^2) = (w1/w2)2 Var(b^2) (6.2.19)

r2xy = r2x*y* (6.2.20)

6-2. Scaling and units of measurement

From one scale of measurement, one can derive the results

based on another scale of measurement. If w1= w2 the

intercept and standard error are both multiplied by w1. If

w2=1 and scale of Y changed by w1, then all coefficients and

standard errors are all multiplied by w1. If w1=1 and scale of

 X changed by w2, then only slope coefficient and its standard

error are multiplied by 1/w2. Transformation from (Y,X) to

(Y*,X*) scale does not affect the properties of OLS

Estimators

A numerical example:

The log-linear model

Semi-log model

Reciprocal model

The log-linear model

Exponential regression model:

Yi= b1Xi b2 e u i (6.4.1)

By taking log to the base e of both side:

lnYi = lnb1 +b2lnXi + ui , by setting lnb1 = a =>

lnYi = a +b2lnXi + ui (6.4.3)

(log-log, or double-log, or log-linear model)

This can be estimated by OLS by letting

Y*i = a +b2X*i + ui , where Y*i=lnYi, X*i=lnXi ;

b2 measures the ELASTICITY of Y respect to X, that is, percentage change in Y for a

given (small) percentage change in X.

The log-linear model

The elasticity E of a variable Y with

respect to variable X is defined as:

E=dY/dX=(% change in Y)/(% change in X)

~ [(Y/Y) x 100] / [(X/X) x100]=

= (Y/X)x (X/Y) = slope x (X/Y)

An illustrative example: The coffee

demand function

How to measure the growth rate: The log-lin model

Y t = Y0 (1+r) t (6.5.1)

lnYt = lnY0 + t ln(1+r) (6.5.2)

lnYt = b1 + b2t , called constant growth model (6.5.5)

where b1 = lnY0 ; b2 = ln(1+r)

lnYt = b1 + b2t + ui (6.5.6)

It is Semi-log model, or log-lin model. The slope coefficient measures the constant
proportional or relative change in Y for a given absolute change in the value of the
regressor (t)

b2 = (Relative change in regressand)/(Absolute change in regressor)

(6.5.7)

Instantaneous Vs. compound rate of growth

b2 is instantaneous rate of growth

antilog(b2) 1 is compound rate of growth

The linear trend model

Yt = b1 + b2t + ut (6.5.9)

If b2 > 0, there is an upward trend in Y

If b2 < 0, there is an downward trend in Y

Note: (i) Cannot compare the r2 values of models (6.5.5) and (6.5.9) because the
regressands in the two models are different, (ii) Such models may be appropriate
only if a time series is stationary.

The lin-log model:

Yi = b1 +b2lnXi + ui (6.5.11)
b2 = (Change in Y) / Change in lnX = (Change in Y)/(Relative change in X) ~
(Y)/(X/X) (6.5.12)

or Y = b2 (X/X) (6.5.13)

That is, the absolute change in Y equal to b2 times the relative change in X.

The reciprocal model:

Yi = b1 + b2( 1/Xi ) + ui (6.5.14)

As X increases definitely, the term

b2( 1/Xi ) approaches to zero and Yi

approaches the limiting or asymptotic value b1 (See figure 6.5 in page 174)

An Illustrative example: The Phillips Curve for the United Kingdom 1950-1966

Table 6.5

Model Equatio Slope = dY/dX Elasticity =

n (dY/dX).(X/Y)

Linear Y = b1 + b2 b2(X/Y) */
b2 X

Log- lnY = b1 b2 (Y/X) b2

linear + b2 lnX
(log-log)

Log-lin lnY = b1 b2 (Y) b2 X */

+ b2 X

Lin-log Y = b1 + b2(1/X) b2 (1/Y) */

b2 lnX

Reciproca Y = b1 + b2(1/X2 b2
l b2 (1/X) ) (1/XY
) */