An Efficient Method of Estimating Seemingly Unrelated Regressions and Tests for

Aggregation Bias
Author(s): Arnold Zellner
Source: Journal of the American Statistical Association, Vol. 57, No. 298 (Jun., 1962), pp. 348-
368
Published by: American Statistical Association
Stable URL: http://www.jstor.org/stable/2281644
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 AN EFFICIENT METHOD OF ESTIMATING SEEMINGLY
UNRELATED REGRESSIONS AND TESTS FOR
AGGREGATION BIAS*
ARNOLD ZBLLNER
Universityof Wisconsin
In this paper a methodof estimatingthe parametersof a set of re-
gressionequations is reportedwhichinvolvesapplicationof Aitken's
generalizedleast-squares[11to the whole systemof equations. Under
conditionsgenerallyencounteredin practice,it is foundthat the regres-
estimatorsso obtainedare at least asymptoticallymore
sion coefficient
efficientthanthoseobtainedby an equation-by-equation applicationof
can be quite largeif "independent"
least squares.This gainin efficiency
variables in differentequations are not highlycorrelatedand if dis-
turbancetermsin different equations are highlycorrelated.Further,
testsofthehypothesisthatall regression equationcoefficient vectorsare
equal, based on "micro" and "macro" data, are described. If this
hypothesisis accepted,therewill be no aggregationbias. Finally,the
estimationprocedureand the "micro-test" foraggregationbias are ap-
plied in the analysis of annual investmentdata, 1935-1954, for two
firms.
1. Introduction ................................. 348
2. EfficientEstimationof SeeminglyUnrelatedRegressionEquations . ........ 349
3. Propertiesof the Two-StageAitkenEstimator . ................. 352
3.1. Moment Matrixand AsymptoticDistribution .......................... 352
3.2. The Gain in Efficiency .............................................. 353
4. TestingforAggregationBias .......................... 354
4.1. Testingwith Micro-Data............................................ 354
4.2. TestingforAggregation Bias withMacro-Data ...... ................... 356
5. Applicationof Methodsto InvestmentDemand . ................ 357
6. ConcludingRemarks ............................. 363
Appendix:................................................................. 363
A. Likelihood-RatioTest forMicro-RegressionCoefficient VectorEquality ..... 363
B. Derivation of the AsymptoticDistributionof the Test StatisticEmployed for
Testing Micro-Regression Coefficient VectorEquality . .............. 366
References ............................................................... 367

1. INTRODUCTION

equations,we considertheproblemof estimating

GIVEN a set ofregression
J! regressioncoefficients It is onlyunderspecial conditions,stated
efficiently.
explicitly below, that classical least-squares applied equation-by-equation
yields efficientcoefficientestimators.For conditionsgenerallyencountered,
we proposean estimationprocedurewhichyieldscoefficient estimatorsat least
asymptoticallymore efficientthan single-equationleast-squares estimators.
In this procedureregressioncoefficients in all equations are estimated simul-
taneously by applying Aitken's generalized least-squares [1] to the whole
systemofequations. To constructsuch Aitkenestimators,we employestimates
* This paper was writtenwhenthe authorwas visitingFulbrightProfessorat the NetherlandsSchool of Eco.
nomicsand AssociateProfessoron leave, UniversityofWisconsin.It is withmuchpleasurethathe acknowledgesthe
benefitderivedfromdiscussions(and cigars)withProfessorH. Theil and Mr. P. J. M. van den Bogaard. Thanks are
also due to Miss E. van derHoeven foraasistancewiththecalculationsand experttyping.

348
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 349
ofthe disturbanceterms'variances and covariancesbased on the residualsde-
rived froman equation-by-equationapplication of least-squares.' While we
apply this estimationprocedurein the analysis of temporalcross-sectiondata,
annual micro-investment data, 1935-1954, we recognizethat the procedureis
more generallyapplicable. For example, it can be applied in the analysis of
data provided by a single cross-sectionbudget study when regressionsfor
severalcommoditiesare to be estimated.Anotherapplicationwould be in time-
seriesregressionanalyses of the demands fora varietyof consumption(or in-
vestment)goods. A fourthapplicationis to regressionequations in whicheach
equation refersto a particular classificationcategory and the observations
referto different points in space, as in Barten and Koerts' analysis of voters'
transitions from partyto partywithinvarious votingdistricts[2].
Further,withinthe estimationframeworka test ofthe equality of regression
coefficientvectors,and thusoftheabsence ofone importanttype ofaggregation
bias, is described and applied in the analysis of micro-investment relations.
Like the estimationprocedure,thistestingprocedureis moregenerallyapplica-
ble. Finally, a procedurefor testingfor aggregationbias which utilizes just
macro-datais developed.
The plan of the paper is as follows.In Section 2 we describethe systemand
the proposed estimationprocedure.Section 3 is devoted to establishingthe
propertiesof estimatorsconstructedin Section 2 and to providingan explicit
statementofthe gain in efficiency oversingle-equationleast-squaresestimation.
We then turnto some aspects of the aggregationproblemin Section 4, in par-
ticularto considerationoftwo testsforaggregationbias, one employingmicro-
data, the othermacro-data.Then the estimationand one testingprocedureare
applied in Section 5. Lastly, we presentsome concludingremarksin Section 6.
2. EFFICIENT ESTIMATION OF SEEMINGLY UNRELATED REGRESSION EQUATIONS

Let
y#- X. + u,A (2.1)
be the ,u'thequation of an M equation regressionsystemwithyMa TX 1 vector
of observations on the u'th "dependent" variable, X,, a TXII, matrix with
rank 1,, of observations on 1, "independent" nonstochastic variables, #, a
l X 1 vector of regressioncoefficientsand u,,,a TX 1 vector of random error
terms,each with mean zero. The systemof which (2.1) is an equation may be
writtenas:
-Yi ~Xi 0 ... 0 -- Uj
? jp:.
[2J= X2 + (2.2)

LYMJ ? .
? . . XM+ 2UM (

Y = X#+U (2.3)
I This procedure,modifiedin certainrespects,has been applied to estimatethe parametersof 'simultaneous
equation" econometricmodelsin reference[13].
350 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962

wherey= [y1ty . . . YM]', i-[31,32. * u* [u1u28 uAA]' and X rep-

resentsthe block-diagonalmatrixon the r.h.s. of (2.2). The MTX 1 disturb-
ance vector in (2.2) and (2.3) is assumed to have the followingvariance-
covariancematrix:
[711I '7121 ...M* iF a(Tii 12 . (..M

(21I (22I . . .q2Mi I 21 '22 . . .a2M

z-V(u I (2.4)

_TM1I 07M21 * * MMI' '7M1 OTM2. . .(TMM_

= X, 01,)
whereI is a unit matrixof orderTXT and o' =E(u,tus,t) fort=l, 2, , T
and ,u,u'=-1,2, **,M.
In temporalcross-sectionregressions, t representstimeand (2.3) impliescon-
stantvariances and covariances from period to periodas well as the absence of
any auto or serial correlation of the disturbance terms.The cT,g with A= /Zare
A
thenthe variances and with uzA'the covariances of the micro-units'disturb-
ance terms (or dependent variables) for any time period. In a single cross-
section budget study where t represents the t'th household and each equation
"explains" expenditure on a particular commodity, is
o,,z, the covariance be-
tween the disturbanceterm in the equation for commodity ,u (or expenditure
on commodityA) and that in the equation for commodity /h' (or expenditure
on ,u') while o, is the variance of the disturbance term in the equation for
expenditure on commodity ,. (or alternatively, the variance of expenditureon
commodity,u). The formof (2.4) implies that the o-, are the same for all
householdsand that thereis no correlationbetweendifferent households' dis-
turbances (or expenditures).Lastly, in application to geographicproblems,
t stands forthe t'thgeographicregionand the formof (2.3) is such that there
are correlationsbetween disturbancesor dependent variables relating to a
particularregionbut not to different regions.Also disturbancevariances and
covariances are assumed to be constant fromregionto region.
In a formalsense we now regard(2.2) or (2.3) as a single-equationregression
modeland apply Aitken'sgeneralizedleast-squares [1]. That is, we pre-multipy
both sides of (2.3) by a matrixH which is such that E(Huu'H') =H2H'=1.
In termsof transformedvariables,the originalvariables pre-multipliedby H,
the system now satisfiesthe usual assumptions of the least-squares model.
Thus application of least-squares2will yield, as is well-known,a best linear
unbiased estimator,whichis
*= (X'H'HX)-'X'H'Hy= (X'-1X)-1X'2-1y. (2.5)

this estimator,we need the inverseof 2 whichis givenby:

In constructing

' The quadraticformto be minimizedin the Aitkenapproachis not the sum ofsquares ofthe originaldisturb-
that ofthetransformed
ance termsbut,as is well-known, disturbances,namelyu'H'Hu, or u'2-'u. As willbe pointed
out below,thereare good common-sensereasonsforapplyingleast squares to the transformed variables,reasons
thanthe classicalleast-squaresestimatorbased
whichmake clearwhyit is thattheAitkenestimatoris moreefficient
on the originalvariables.
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 351

1- = V-l(U)= . . 0I (2.6)
LoM 1I ... o.MMI

ThentheAitkenestimator vector,givenin (2.5), is

ofthecoefficient

bi 102llXlXl 712XlX2 ... o.lMXlXM -1

b* [Tb2 = ,2lX2Xl <022X2X2 ... OT2MX2XM

bm M cM2XMX2 * MMXMXM (2.7)

x X
L
_I
E
M
O'X14X

Sm#yul

and the variance-covariance

matrixofthe estimator
b* is easilyshownto be
or

[o'11XXi o012XlX2 ... OlMXlXM

V(b*) = 21 o22X2X2 * *MMXMXM (2.8)

crMl.XwX
(mXxl uM2X/vX
SM'XX2 .. * (MMX'MXM_i

The estimator in (2.7) possessesall oftheusualoptimalproperties ofAitken

estimators; that is, it is a best linearunbiasedestimator.3 Further,withan
added normality assumption, it is also a maximum-likelihood estimator. It is
to be notedthat (2.6) is identicalwithestimators providedby single-equation
least-squaresif the disturbance termshave a diagonalvariance-covariance
matrix,i.e., if a,, = -,= O for , Also, if Xl = X2= ... = XM, (2.6)
"collapses"to yieldsingle-equation least-squares estimators evenifdisturbance
termsin different equations are correlated (a,,,5i0), and these are,as is well-
known,the same as maximum-likelihood estimators. However,whenthe X,
arenotall thesameand whenthedisturbance termsin different equationsare
correlated,the estimatorin (2.6) will differ fromthe single-equation least-
squaresestimators.
If 2 is unknown, as it usuallyis, it is impossible to use (2.6) and (2.7) in
practice.Whatwe proposeto do is to employan estimateof {o' } in construct-
ingtheAitkenestimator. This estimateiS,4
8 The single-equation least-squaresestimatorofthe coefficient vectorin (2.2) is a memberofthe linearclass of
estimatorsto whichtheAitkenestimatorbelongs.
4 Here,forsimplicity, we assumethat thereare "independent"variablesin each regression. Then thevariance
estimatorsin (2.9) will be unbiased. However, the covarianceestimatorswill only be asymptoticallyunbiased.
Whentheindependentvariablesin different equationsare highlycorrelated,as is the case in manyapplications,the
small-samplebias in the covarianceestimatorsin (2.9) willbe small. In reference[14,p. 14] an unbiasedcovariance
estimatoris presented.
352 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962
A
(T - 1)2e = (T -){s,} = yu } = _(Xy-XA)'(yy - Xq)} (2.9)
where A, is the usual single-equationleast-squaresestimator,(X, X')-XPy y.
Thus (2.9) is an estimateof the disturbancevariance-covariancematrixformed
fromthe single-equationleast-squaresresiduals. Given that we have the esti-
mate {s,, we can obtain by inversionthe matrix{s'1" } the elementsofwhich
are employedto formthe estimator:

Fl
-b1 -
~~1Xs'C
s X12 -1 M
llXX sl2X1X2 ... S1MXlXM
1XX
s21X'Xl s22X'X2 s.
*S2MX'XM [u=l

b= 1{{1 (2.10)

_bM_ sMMlX X sM2X X2 * MMXIXM E sMAXMy

It will be shown that b=b*+O(T-l), that T"12(b-3) and Tl12(b*-3) have the
same asymptoticnormaldistribution,and that the momentmatrixof b is:

[s"iXlX s12X1X2 .. 'X X

21Xs Xl s22XX2 ... s2MX'XM -
V(b) = ... sMMXJXM + o(T-71) (2.11)

sM1XmXl sM2XmX2 ... SM MXM-

where O(T-1) denotes a quantity which is of the order T-' in probability

and o(T-') denotes termsof higherorder of smallnessthan T-'.

3. PROPERTIES OF THE TWO-STAGE AITKEN ESTIMATOR

Distribution
3.1. MomentMatrix and Asymptotic
We now turnto providingproofsofthe statementsmade at the end ofSection
2 regardingthe propertiesof the estimatorin (2.9).
Let 2e= (2+A,) 0I be the estimateddisturbancecovariance matrixwhere
1 0 1 is givenby (2.3) and A1is a matrixwhoseelementsare the samplingerrors
of the single-equationleast-squaresestimatorsof the elementsof 2X:and these
samplingerrorsare knownto be O(T-1"2)in probability(-i.p.). Thus,
2e1 (2c+ Al)l X - [2c1 _ c 12c +***] I (3.1)
=-2 - 2 ...

and

A2 = ? i =

where 3(2), is O(T-112) i.p. and terms of higherorder of smallness have been
neglected.Now the two-stageAitkenestimatoris
b = (X'2; 'X)-'X'2;'ly
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 353
or
b -
- WX3
= ( IX)- X/ e lu

wherey--(y, y2,* * *, yM)',u- (u', u, * * *,uXk)', b= (bV,

b', , bY)', A(j31,
2...**, and
3,M)' X denotes the block-diagonal matrix on the r.h.s.of (2.2).
Then utilizing(3.1), we have
b- A = [X'(- - A2)X]-lX'(- - A2)U
= { [X'2-'X] [I - (X'-1X)-'X'A2X] }I-1X'(T-1- A2)U (3.2)
[(X'1T1X)-1 + (X' 12X)-'(X'A2X)(X'T2'X)-' + . . . ]X/(7-1- A2)U

wheretermsof higherorderof smallnessthanO(T-11)have been deletedin

thesquarebrackets.Rearranging
terms,we find
b - 0 = b* - 0+ A3) (3.3)
whereb* is the "pure"Aitkenestimatorand
A3 = - (X'T1_X)-'X'A2U + (X''--lX)-lX'A2X(X''-lX)-lX'r-lu, (3.4)

termsof higherorderof smallnessbeingagain neglected.Considering the

secondtermon ther.h.s.of (3.3) we observethatX'I-lu is O(T1/2)i.p.,which
meansthatthetermas a wholeis O(T-1)i.p. The sameappliesto thefirst term,
fortheorderofX'A2uis thatofA2multiplied by thatofX'u, thatis, 0(1).
If we thentaketheexpectation ofbothsidesof(3.2),we findthatthebias of
b is at most of O(T-1). Furthermore, since b*-,f is O(T-1/2)i.p. and A3 is
O(T-1) i.p., the asymptotic covariancematrixof b-,B is the same as that of
b*- j. Finally,sinceit is knownthatundergeneralconditions theasymptotic
distribution of T12 (b*-,P) is normal,theasymptotic distributionof T"12(b-j)
is thesameas thatof T112(b*-,B),becausethedifference ofthesetwo quanti-
ties,T1/2A3, has zeroprobability limit;seetheconvergence theorem in reference
[5,p. 254].
3.2. TheGainin Efficiency
Since the Aitken estimatorof {to3,3,
2 * * *, ,B }' in (2.2) differs
fromthat
derivedby applicationof least-squares equation-by-equation, it mustbe the
casethattheAitkenestimator is moreefficient.Essentially,thisgaininefficiency
occursbecausein estimating the coefficients of a singleequation,the Aitken
procedure takesaccountof zerorestrictions on coefficients occurring in other
equations.These zerorestrictionscan be seenclearlyifthe systemin (2.2) is
rewrittenas:
-1 0 ..*O -

(YlY2 ... YM)= (X1X2** XM) + (UU2 ... UM). (3.5)

0 O ** *M
354 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962

It is instructiveto considera system'with a disturbancecovariance matrix

such that u =c,-2 and cr-c=2p for ot,&/',or z_=o-2 [(1-p)I+ pee'] whereI is
a unit matrix of size MXM and e'= [1, 1, ** *, 1], a 1XM vector. Then
27'= aI-,yee' with r-l=uf2(1-p) and y= ap/[1+(M-1)p]. Then forthe co-
variance matrixof the estimatorb*, we have
V(b*) [X'(T,-' 0 I)X]-1
((X )X1X1 -YX1 X2 *** -7X1 XM -1
-yX2 xl ( )X2 X2 *X (3 6)

-,YXMX1 -YX'MX2 *.. (CX- 'Y)XM'XM]

For the two dimensionalcase (M =2) the covariancematrixofthe firstequa-
tion's coefficient
vector estimatoris:

V(bfl = [(a - y)X'X1 - X1_1 -X1X2(X2'X2)-1X2' (3*7)

(x-y

and it can be shownthat [cf.14]

| V(b*) p| (1 11 (3.8)
II (1 - p2r,)

where 1 is the numberof independentvariables in the firstequation (11l 12)

and r,uis the M'thcanonical correlationcoefficient associated with the sets of
variables in X1 and X2. Since 0 <r2 < 1, it is clear that the generalizedvariance
of b* will be smallerthan or equal to I a2(X'X1)-11, the generalizedvariance
of the "single-equation"least squares estimator of the firstequation's co-
efficientvector. If r, = 0 for all ,u,as would be the case if X'X2 = 0, the ex-
pression in (3.6) reducesto (1 - p2) 11l 2(X'Xi)-l I whichrepresents theminimal
generalizedvarianceforgivenp and a,2.
Furtherfrom(3.6), withX, X,,= 0 for, we obtain

V(bfl = [ -1 - 1 ar2(X X1) 1 (3.9)

_ l+p(M -1)

and thus as the numberof equations, M, approaches infinitywith XX,, = 0

for,u,,'
= 1,2, * * * ,M and Iu5x,', thenV(b*)approaches(1-p)0f2(X1X1)-1.

4. TESTING FOR AGGREGATION BIAS

4.1. TestingwithMicro-Data
It is, of course,possibleto develop tests of a varietyofhypothesesabout the

5 This case was suggestedto the authorby one oftheJournal's editors(cf. [14] foradditionalresults).Since we
have illustrativepurposesin mind,we neglectthe fact that elementsof thedisturbancecovariancematrixmustbe
estimated.
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 355
coefficientvector in (2.2). One particularlyimportanthypothesisin the case
that X1, X2, * * *, XM are all of the same size and representmatricesof obser-
vations on particularvariablesrelatingto different micro-unitsis the following
one:
Ho: f1i= 32 =***-AM. (4.1)
are homogeneousinsofaras their
The hypothesisin (4.1) statesthat micro-units
vectorsare concerned.Furtherif (4.1) is valid, therewill
regressioncoefficient
be no aggregationbias involvedin simple linear aggregation[7, 11]. That is,
with simplelinear aggregation,we form6
y= Sy# X=Zx X

and estimate: in:

y=
X8+
3 U(4.2)
where

The expectationof the least-squaresestimatorof j8 is givenby:

Eb = B (4.3)

where B, = (Y'Y)- 1'X,. Clearly

?B, = I since >X,, E X.

Thus if hypothesis(4.1) is true,the expectationof the macro-estimatorb will

be equal to the micro-parameter vector.
In testing(4.1), it is necessaryto use a test statisticwhichtakes account of
the fact that the disturbancesin the micro-regressions are correlated.For-
tunatelysuch a test has been describedin the literature[10, p. 82]. The test
statistic,employedfortestingsuch restrictionson regressionsystems,is given
by:
n- m
Fq,n_m-
q
y'2z-X(X'2;-iX)-iC/ [C(X'2;-ix)-iC']-lC(X'2;-lx)-lx'2;-1y(4*)
X y'/2r'y - y

wheren is the numberof observationson y,m the numberofindependentvari-

ables, q the numberof restrictionson the system,and C the matrixof the re-
strictions,Cf = 0. In terms of the system in (2.2), n = MT, m= Ml and
q = (M - 1)1. The restrictionsgiven by the hypothesis(4.1) can be expressed
as follows:

6 ofthisaspect oftheaggregationproblemis presentedby Kloek [7].

This convenientmatrixrepresentation
356 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962

-I -I 0 0 0 o- -0- o

O I -I ... 0 0 0 02 0

C,B= _ . (4.5)
O O O *.*. I -I O
0 0 0..* I -IJ FM
m _0_J
Theunitandzeromatrices in (4.5) are oforderIX 1.Thusthereareq= (M -1)1
as statedabove.Roy's [10,p. 82] veryelegantderivation
restrictions, ofthis
testdoes not involvethe likelihood-ratio approach.However,as shownin a
straight-forwardmannerin AppendixA, the likelihood-ratio approachleads
to the same test statistic.If the disturbance covariancematrixwereknown
(4.4) wouldgivean exacttestof the hypothesis in (4.1). Whenan estimateof
thismatrixis employed in constructing theteststatistic,we showinAppendix
B thatthe resulting statistic,say P, is equal to the statisticin (4.4) plus an
errorwhichis 0(n-1/2)in probability. Thenby a theorem in [5, p. 254], F will
havethesameasymptotic distribution as Fq,n_m.But,as showninAppendixA,
-2 log X=qFq,n-m+0(n-l) where X is the likelihood ratio for testing the
hypothesis in (4.1). It is known[8, p. 259 and 12,p. 151] that -2 log X,and
thus qFq,n-m (and qP), is asymptotically distributed as x2=X(M1)z, where
l(M- 1) is thenumberofrestrictions involvedin (4.1).
For smallsamplesthereis some questionabout how to proceed.We can
computeqF anduse qP's asymptotic distribution,
X., assuming thattheasymp-
toticresultsapply.Anotheralternative, whichmaybe better,wouldbe to as-
sumethatP's distribution is closelyapproximated by thatofFq,n-m.7

4.2. TestingforAggregationBias withMacro-Data

Whenjust macro-dataare available,it is customary to estimatea macro-
relation,forexamplethat (4.2), and thento proceedas if no aggregation
in
biaswerepresent.Obviously itwouldbe desirableto havea testofthehypothe-
sis of no aggregation one whichemploysjust macro-data.
bias, particularly
A testof thissortis developedbelow.Initially,we restrict ourselvesto con-
siderationof a simplesysteminvolvingtwo micro-regressions, each withone
independent variable:
=
{YM(t)-311xi(t) + #lo+ ui(t) (4.6)
Y2(t) = 321X21(t)+ f20 + U2(t).

obtainedby adding these two micro-

macro-relation,
The corresponding
equations, is:

y(t) = +(t) (t) j]X(t) + j%

+ fi(t) (4.7)

where,as before,a bar overa variabledenotesa sumofmicro-variables. Now

ofX(t)
it is seenthatthe coefficient in (4.9) is a weightedaverage j13 and
of
7 A similarproblemarises in connectionwith the small-samplepropertiesof identifiability
test statisticsin
reference
[3].
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 357
these
a21withweightsw1(t)= xii(t)/ [xll(t) +x21(t)] and 1- w1(t). Introducing
weights
explicitly,
(4.7) becomes:
y(t) = f21;T(t)+ (l - + 10 + u(t).
2132)wl(t)x(t) (4.8)
If data are available giving wi(t), t= 1, 2, * * *, T, it is possible to formthe
variable wl(t)x(t),run the regressionin (4.8), and test the hypothesisthat the
ofwl(t)x(t) is equal to zero.This is a testofthehypothesis
coefficient jll = 321
and ifacceptedas truemeansthatno aggregation biasis present.In a practical
case,w1(t)mightbe a firm's proportion salesinyeart.Data on mar-
ofindustry
ketsharesmightbe availablewhilemicro-data oncertain"dependent" variables
mightnotbe available.
If data on w1(t)are not available,it maybe thatan investigator is willing
groundsor on someotherbasisthatwi(t)is
to stipulateon a prioritheoretical
a function of a variableforwhichdata are available.To be specificsuppose
On substitutingin (4.8) we obtain:
w1(t)= axo+ax1Z(t).8
y(t) = [021 + aoQ3(n - 021)]X(t) + (O1k - 021)aiZ(t)i5(t) + 1o + u(t). (4.9)
Now,regressing9 y(t)on x(t) and Z(t)xt(t)and testingthehypothesis thatthe
ofthesecondvariableis zeroconstitutes
coefficient a testofthehypothesis of
equalityofmicro-parameters and thusofno aggregation bias.
This testingprocedurecan easilybe extendedto covermorecomplicated
For example,if thereare M micro-regressions
specifications. in (4.6) rather
thantwo,(4.7) becomes:
M-1
y(t) = 3MlX(t) + E (Oil - Ml)Wi(t)t(t) + 1o + i(t) (4.10)
i=l

wherew,(t)=xil(t)/x(t). If we now have wi(t)= aoi+aiZ(t), thislast expression

becomes
- M-1-
y(t) = 1M1 + (Oil - Omi)aoi X(t)

-M-1-
r zl
M-11(4.11)

+ [E (i - ml)ai Z(t)t(t) + 1o + U(t).

Again a simpleregressionof y(t) on X(t) and Z(t)x(t) is all that is needed to test
the hypothesis of micro-parameter equality.Further,the procedurecan be
extended to applyto systems withmorethanoneindependent variablein each
regression.In all cases,however, is
theapplicationofthetest conditional upon
therebeingmeaningful the wi,and somevari-
relationsbetweenthe weights,
able or variablesforwhichdata are available.
5. APPLICATION OF METHODS TO INVESTMENT DEMAND
To illustrate
themethods above,weutilizetheinvestment
described equation
developedby Grunfeld
[6] and in Boot and de Witt [4]. Grunfeld's
described
8If thisrelationis stochastic,say, wi(t) =ao +alz(t) +v(t), wherev(t) is a stochasticdisturbanceterm,the ap-
proachshownbelowleads to a regressionmodelin whichone (or some) oftheindependentvariableshave "measure-
menterror."Problemsofestimationand testingassociatedwithsuch modelsare not consideredin thispaper.
9 It is assumedthat Z(t) is an exogenousvariable.Or alternatively,Z(t) can be a polynomialin exogenousvari-
ables.
358 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962

investmentfunctioninvolves a firm'scurrentgross investment,I(t), being

dependenton the firm'sbeginning-of-yearcapital stock,C(t -1) and the value
ofitsoutstandingsharesat thebeginningoftheyear,F(t - 1). That is, themicro-
investmentfunctionis:
I(t)=ao + alC(t-1) + a2F(t-1) + u(t), t-1, 2, * T. (5. 1)
Hereinwe presentestimatesof (5.1) for two firms,General Electric and Wes-
tinghouse,by the methoddescribedabove and by single-equationleast-squares.
The annual data, 1935-1954, are taken fromreference[4].
For conveniencewe relabel the variables as follows:

Firm I(t) C(t-1) F(t-1) 1

GeneralElectric yi(t) xii(t) x12(t) xis(t)

Westinghouse y2(t) x21(t) x22(t) x23(t)

The equation systemto be estimatedis then:

Y82_ 0? X2] #12- U2]

where Xj(t) = [xnQ(t)x12(t)x13(t)], x2(t) = [x21(t)X22(t)x23(t)], Al= [I311312P10] and

02= Let Z1= [yiXi] and Z2= [Y2X2] and Z= [Z1Z2]. In our case we
[i#21#22020].
have forthe submatrices'0of Z'Z:
254113.50 1005863.46 4093308.29 2045.8-

.1..j
Yl'Yl
y11 yi'lIx
... . *=4395946.84 15769824.07 8003.2
_L
xi, * xi' _ 78628914.21 38826.5
20
Y 103869.607 221467.99 * 1531586.94 2045.8-

L...
t YI'2lX2 ~ . . . . . . . . . . . . . . . . . . . . . ..
. ... .
=413156.104 974281.31 6153588.29 8003.2. .

_Xly2 1X;X2 J 1719503.680*3369944.27*27247303.72*38826.5

L 857.83 * 1712.8 13418.2 20 _
-
43732.4023 90592.412 643262.570 857.83-
Y2'Y2 y* X2 .1 ..

.220345.72
. 1344261.18 1712.8
1=I
LX2yY2X21 X2 9942109.78 13418.2
20 1
and the remainingone is just the transposeof one already shownabove.
10Justtheupperpartsofsymmetric matricesare shown.It shouldbe notedthatthe elementsofV2 are givento
twodecimalplaces in the originaldata whereasall otherdata are givenaccurateto one decimalplace.
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 359
We firstcompute the single-equationleast-squares estimates in the usual
way to obtain:
0.151693870] 0.092406491
L1J[0.9026551189
F0211
$1
= = and A2 =2 0.052894127].
L"O"
1oJ -9.956306513J L p20 J L-0. 509390038J

To get the estimateddisturbancecovariance matrixconveniently,we write

[Yl Y2] [X1X2]

[0 A32+ [u U2]

or
Y=XB+ 0.
Then,
OTo = (Y - XB)'(Y - XB) = Y'Y - B'X'XB
[Y1 Yi Y1 Y2 [1 X;fX111 1 Xl X202
Y1y2 2
_y2 0_p2X-A X11 fX2/X2f2
[13216.5899 3988.01181
L 1821.28081'
which is equal to (T -3){spg} where T = 20, the numberof observationson
each variable. We now invertthis last matrixto obtain (T-3) -1{I8}:
- .000223009584 -.000488319216-
_ .
~~~~.00161832608
We can now obtain the estimate of the moment matrix of the two-stage
Aitken estimatorsby formingand invertingthe followingmatrix:
r Xll sl2X IX2]
X21XXl s22XI X2

The inverseof this last matrixis shown below. Elements on the diagonal are
estimated coefficientestimator variances while off-diagonalelements are
estimatedcovariances.
.0006006 - .0000360 - .1704 .0007562 - .0000197 - .0515761-
.0001885 - .3516 * - .0003914 .0001447 -.0635894
789.6028 .4573140 -.2731373 155.8156
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
.0026914 - .0005191 .1177480

L .0001972 - .0878539
54.2149
360 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962

To obtain two-stageAitkencoefficient
estimates,we multiplythe last matrix
into the followingvector:
22.565127-
73.180290
0.037338
[s1 Xy1+ s2XLY21=(T - 3) . . . . . .
1Ls21X2
LS21X?i 2
s2 Y2X_'y
Iy, + s22X2
38.460988
293.105260
0.389245_
The pointestimatesso obtainedalong withtheirestimatedvariancesare shown
in Table 1. Also shownare the single-equationleast-squaresestimatesand their
estimatedvariances.

TABLE 1. RESULTS OF TWO-STAGEAITKEN AND SINGLE-EQUATION

LEAST-SQUARES ESTIMATION OF MICRO-
INVESTMENT FUNCTIONS

Two-Stage AitkenMethod Least-Squares

MicrounitCoefficient
of Coefficient Variance of Variance of
Coefcient coefficient Coefficient coefficient
estimate estimator estimator

General C-i .1326 .0006006 .1517 .0006605

Electric F-1 .0421 .0001885 .0266 .0002423
1 -32.4807 789.6 -9.9563 984.1

Westinghouse C-1 .0459 .002691 .0924 .003147

F-1 .0611 .0001972 .0529 .0002468
1 -2.0113 54.21 -.5094 64.24

It is seen fromthe results in Table 1 that application of the estimation

proceduredescribed above has resulted in a significantreduction (about 20
per cent) in the estimated coefficient estimatorvariances as compared with
those of single-equationleast-squares.The estimatedcorrelationbetween the
disturbancesin the two equations is 0.81. Thus fromwhat has been said in
Section3.2, the maximumgain to be expectedis approximately1 - (0.81) 2 = 034
times the single-equationestimated variances. That the maximumgain was
not realized is due to the fact that X1X2#0.
We note also in Table 1 that the pointestimatesyieldedby the two methods
differ.This is to be expectedsince differentquadratic formsare minimizedin
the two approaches and also, obviously,if one method is more efficient than
another,the estimates yielded by the two methods cannot always, or even
usually,be identical.What it is importantto realizeis that it makes good sense
to use the Aitken quadratic form.In this formwe have weighteddeviations;
SEEMINGLY UNRELATED t1EGRESSIONS AND AGGGREGATIONBIAS 361
that is, the data in the sample are not all given the same weight but are
weightedby elementsof the covariancematrix'sinverse.In a single-equation
case with heteroscedasticity present,this means weightingthe square of each
deviation by the reciprocalof its variance, an extremelysensible procedure.
With the use of directleast-squares,all squared deviationsare given the same
weight,a ratherunsatisfactory weightingofthe evidencein the sample. Similar
considerationsapply to use of Aitken's quadratic formin connectionwith
equation systems.
We now turn to an application of the test for micro-parameterequality,
describedin Section 4.1. In the presentapplication,the numeratorof the test
statisticis from(4.4):

M(T -1)
r2
[y=1
Y'sM'Xi~2yISA2X2j
2

p-l ]
FX'X1s"l

[X2'Xis2l X2'X2s22
JL-I Il
Xi X2s'12 1-
(5.2)

X {[I I] Xe
X1s21 X2822j-IM

[II XlX1s"
X2Xis21
XLX2s'2 -1 C
X2'X28s2 I IX/
~1M~
2

where s8y'has been substitutedfor u88'; M-=2, l1=3, T -1=17 and the unit
matricesare of size 3 X 3. Most of the expressionsappearinghave already been
computedin the estimationofthe system.However,the second inverseappear-
ing in the expressionmustbe computed.We have
[XlXis"l XlX2s121-1[ I] i,
[B11 B121[
A = -]LX2X1821 X2,X2822 -I -2 -2 22

=-[(B1 - B21) -(B12 -B22)],

wherethe definitionof Bti is obvious and the inverseof A isu:n

3)'A' [86.805843 2:4091 .125732]

LB[B2IL J
-

L2_B21 B221

Then we form
[B11 B121[_ lA-1[I -XI] [B12 B121

[(B1 -B12)A-'(B1- B21) (B1- B2)A-'(B12-B22)1

BlB2I -BB21)(B21-BB22)A-'(B12-B
-B22)A1'(B1
a symmetricmatrixwhichwe calculated as, (T-3)-1 times
11The factor(T-3)-1 comesisince we have used (T-3)-YI (s'I ratherthan ( 841} .
 [
362 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962

.004370 .000520 -3.278245 .007015 .000798 - 1.2585031

.002809 -5.853262 - .005526 .002064 -.9572631
13326.484 7.392666 -4.519575 2552.105 1
.039913 - .007692 1.620036
.002956 - 1.369759
824.8936111
The last step in calculationof the numeratoris to pre- and postmultiplythis
last matrixby the vectorsshownin (5.2) whichare given above. The resultis
0.582278 which must be multiplied by M(T-1)=2(17)=34 to yield
19.797(T-3) whichis the value of the numeratorof the test statistic.
The denominatorof the test statisticin (4.4) is, with sAW'
replacingao':
2 2 r 2 2
y
{-

(M - 1)1{[ Y S,lyi + 2 y 8,2Y2 - Y 28lXl y882X2

y=1 y=1 y=1 2
.3)
~~~~~~~~~(5
[2

X11X1sl XfX2s822-iJE= x,s1Myy

[x2'Xis2' X2'X2s22]L X2'4y

expressionhas been computed with the exceptionof:

(T - 3)-1[ Ey I syl + E y,L2yI ] = 26.000130.

Then by directoperations,(5.3) is calculated to be equal to

(M - 1)1(1.911752)(T - 3) = 3(1.911752)(T - 3) = 5.735(T - 3).
WTenow have:
19.797
1
= = 3.452.
5.735

As mentionedabove, thereare at least two alternativeprocedures,each with

its own approximations,which are candidates for testingthe hypothesisin
(4.1): (a) we can utilize the fact that qF is, as shown in Appendix B, asymp-
totically distributedas x2 with q = (M - 1)1 =3; or (b) we can assume that
since F and Fq,n-mdifferby an amount whichis O(T-1"2) i.p. the distribution
of P will be closely approximatedby that of Fq,n_m.The relevant95 per cent
criticalvalues for (a) and (b) are: X2(.95) = 2.605 and F3,u(.95) = 2.88. Thus,
in this case, both procedureslead to rejection,at the 95 per cent level, of the
hypothesisof regression-coefficient vector equality and, therefore,in simple
aggregationbias will probablybe present.'2
12 The macro-test foraggregationis notappliedsincein thisinstanceno meaningful
relationsfortheweights(see
above) are available.
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 363
6. CONCLUDING REMARKS

We have presenteda methodofestimatingcoefficients in generallyencountered

sets of regressionequations whichis more efficientthan an equation-by-equa-
tion applicationof least-squares.Applicationof this methodto estimatemicro-
investmentfunctions'3has led to estimatesof coefficient estimatorvariances
about 20 per cent smaller than those of equation-by-equationleast-squares.
Such a substantialreductionin these variances is indeed a satisfyingfeature
of the application shownabove, a featurewhichwill characterizethose appli-
cations to systemsin whichthe disturbancesof different equations are highly
correlatedand the independentvariables of different equations are not highly
correlated.Further,while we have applied (and also discussed) the procedure
foronlythe situationinvolvingone regressionper micro-unit, it is also possible
to extend the methodto situationsin which these are several regressionsper
micro-unit.
Lastly, we have describedtwo testsforaggregationbias, one a "micro-test,"
the othera "macro-test."The micro-testwhichtakes account of the fact that
an estimated disturbancecovariance matrix is employed in the test statistic
involves test of an importanthypothesis,namely that, in our application,
differentmicro-unitsare characterizedby the same regressioncoefficients.
Clearly this is importantknowledgeand the test which providesit should be
applied. Finally, the macro-testforaggregationbias, describedabove, requires
knowledgethat certainauxiliaryrelationsare true. This is, at present,a weak-
ness ofthistest. How one proceedswhenone is uncertainabout the validityof
these auxiliary relationsis an open question. Then, too, when the auxiliary
relationsare stochastic,otherproblemsarise, as noted above. These are issues
which will receive attentionin futurework.
APPENDIX
A. LIKELIHOOD-RATIO TEST FOR MICRO-REGRESSION COEFFICIENT
VECTOR EQUALITY

Under the hypothesis(4.1), 31=-/2 * i the systemin (2.2) can be

writtenas

or
y = Zf1 + u.
Now transformvariables by premultiplicationby H where H is such that
E(Huu'H') = aI. Let Hy=y, HZ-Z and Hu=u. Then we have forthe likeli-
hood functionunderthe hypothesis,L(co),
IsIt is possibleto employthecoefficient
estimatesto obtaina newestimateofthedisturbancecovariancematrix
and thena new set of coefficientestimates,and so on. The small-samplepropertiesof thisiterativeprocedurehave
not as yetbeen established.
g64 AMERICAN STATISTICAL ASSOCIAtION JOIYRNAL, ITUNJt1960

-I (A. 1)
L(wo)= (2r) -'(T )2MT exp [- ./]2
Whenmaximum-likelihood are substituted
estimators in (A.1), we obtain
-',M T A2
--M T
L(o) (27r) exp [-'MT]
()

= (o,,
where42 = (1/MT)uf'U=(1/MT)(y- A1)'(y- A1) and b1=(2'2)- '1'.
Underthehypothesis Q involving
no restrictions
on thecoefficients,
we have
thesystemin (2.3). Againwe transformthevariablesby premultiplication
by
H to obtain:
y
= 3+u,
wherey=Hy, X=HX and u=Hu. The likelihoodfunction
nowis:
-LMT 2 --j'MT
(Q)= (27r)(-j ) exp
whichuponsubstitution
of maximum-likelihood
estimatesbecomes:
1M T 2 -M T
( (27r) 2 g) exp [-'MT]
wherea= (1/MT)>', = (1/MT) (-Xb)'(y-Xb) and b- (k'k)-'X'y.
The estimated
likelihoodratio,X,is then
L 0co (^ )-1
2)
-
L)_(A 2MT T
(&2>M
and

-2 logX = MT log

whichis asymptotically
distributed
as X2(M-1)1 [cf.8, p. 259 and 12,p. 151.].
We mustnowshowthat
2
0-co ~q
= 1+ (A.2)
2
OD
n
n-rm
Fq,n_m

whereFq,nm is givenby (4.4) and q= (M-1)l and n-m=M(T-1). If (A.2)

holds,we canwrite[cf.8, p. 262]

n log- n log 1+ q
= Fq,n_m

m n-r n-rnm
n n- m (n - m)F
-qFq, nm + O (n' )
SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 365
and thenby theconvergence theorem in Cramer[5,p. 254],n log &2/&a=MT
log 62/52and qFq,n =(M-1)lF(M-1)l,M(T-l) have the sameasymptotic dis-
tribution,namelyX%.
To showthat(A.2) is valid,we write:
2 2
q ?CDA A

Fq,n_m= 2
n-rm O
-Zbil(y- Zbl) - -Xb) - Xb) (A.3)
(-Xb'(-Xb)

b'X'Xb - b Z'Zbl 'X(X'X)-'X'' -y2('Z)-lZ

-b'X'Xb -

Now the denominatorof this last expressionis y'2-1y-y''-1X(X'2-1X)-1

XX'2-iy in termsof the originalvariablesand this is the denominator
of
[q/(n-m)]Fq,n-m;see (4.4). The numeratorof (A.3) is
y/2-J[X(X/X-lX)-1X - Z(Z'X-rZ)-'Z']J-ry. (A.4)
Now
Xi[XiO0... 1
X2 0 X2 ... 0 1

xml0 0 ...Xi[L_I1
Then(A.4) becomes:
whereJ is a columnofunitmatrices.
y1-1x[(x/2;-X)- - J(J/X''-lxJ)-'J']X'2-iy

or
y'T-1X(X'2-1X)-1[X'2-lX - X'2>-XJ(J'X'2'-'XJ)-'J'X'2;-X]
*(X'2;-'X)-'X'2;-Iy. (A..5)
of { q/(n-rm)} Fq,n_m,
For (A.5) to be equal to the numerator we musthave
X2_1X - X'21XJ(J'X'12-'XJ)-1J'X'2;-X = C'[C(X'2-1X)-1C']-lC.

That thislast equalityis trueis establishedby premultiplying

bothsidesby
C(X'2-'X)-l to obtain:
C[I- J(J'X'2-'xJ)-'J'X'2-'xl = C.
Thenpost-multiplying
bothsidesby J to obtain:
C[IJ - J] = CJ.
Fromthe definitionofC and J, it is seenthatbothsidesofthelast equation
are just zeromatrices.Thus thevalidityof (A.2) is established.
366 AMERICAN STATISTICAL ASSOCIATION JOURNAL JUNE 1962

B. DERIVATION OF THE ASYMPTOTIC DISTRIBUTION OF THE TEST

STATISTIC EMPLOYED FOR TESTING MICRO-REGRESSION
COEFFICIENT VECTOR EQUALITY

In this part we establishthat whena consistentestimate2, of 2 is employed

in (4.4), the resultanttest statistic,say F, is equal to Fq,n-, plus an errorwhich
is ofordern-1/2 i.p. and thusthattheyhavethesameasymptotic distribution.
For the denominatorof F aside froma multiplicativefactor,we have

Y,2e ly- y'2;1X(X'1X>1X)-lx/2e;ly (B.1)

or, with2=2+,A,
y'(2 + Al)-ly - y'(2 + A1)-1X[X'(2 + A1)-1X]-lX'(m + Al)-ly,

whereA1is O(n-1/2) i.p. We now make the followingexpansions:

(2 + Av1)-1
= --1-2-lz- + * * * = ~2- + A2 (B.2)
and
[X'(2 + Al)-1X]-i- [X'(2-1 + A2)X]-1
- (X'2 lX)-l- (X'2-lX)-lX'A2X(X'2lX)-l + ... (B. 3)
= (X'2-lX)-l + A32

where,i.p., A2 iS and A3 is 0(n-1 1/2). Utilizingtheseresults,(B.1)

O(n-1/2)
becomes:
y'(z-l + A2)y - y'(Tr1 + A2)X[(X'2-lX)-l + A3]X'(2;- + A2)y
or
y2;-ly _ y'T1X(X't2lX)_lX'Z_ly + A4

whereA4 iS in (B.1) is equal to the quantity

0(n1/2) i.p. Thus the expression
appearingin the denominatorof (4.4) plus A4,orX.2-n+A4
For the numeratorof F, again aside froma multiplicativefactor,we have
y12;-lX(X,2;-lx)-lc/[C(X/2e lx)-lcf]lC X2eX X2

- y'(21 + A2)X(X'2-1X + X'A2X)-lC'{C[(X'2-lX)-l + A3]C'}-1 (B.4)

X C'(X'2h-X + X'A2X)>'X'(1-l + A2)Y

where (B.2) and (B.3) have been employed.Now the followingexpansionsare

required:

(X'2 1X + X'A2X)-1 = [I + (X'2-1X)-lX'A2X]-1(XZ-'1X)-1

= [I- (X'-lX)-lX'A2X + (X'2--X)-l (B. 5)
= (X2'-1X)-l + A5,

whereA5is O(n-1 1/2) i.p., and

SEEMINGLY UNRELATED REGRESSIONS AND AGGREGATION BIAS 367

{c[(X'T-1X)-1 + A 3]C}' -= {C(X'T-'X)-'C' + CA3C1}-1

- }-1[C(X'2-1X)-1c']-i
I + [C(X'Z-1X)-1C']-1CA3C' (B 6)
= {- [C(X''-1X)-1C']-1CA3C'+ * } [C(X'3-'X)-'C'] (
= [C(X'3-1X)-1c']-1 + A6,

where A6is 0(n112) i.p. Substituting(B.5) and (B.6) in (B.4), we obtain:

y'(X-1 + A2)X[(Xfy-1X)-l + A5]C'{ [C(X'T-1X)--1C1]-1+ A6}C'
X [(X'T1_X)-1 + A5]X'(2-1 + A2)y
whichupon expansionbecomes
y's2-lX(X'y-lX)-lC'[C(X'y-lX)-lC']-lC'(X'X-lX)-lX'y-ly + A7,

or just the quantity in the numeratorof (4.4) plus A7 which is 0(n"/2)i.p.,

or x2+A7.
Then we obtain fromthe above results,
2 2
n-m Xq+A7 n-rm X (1 +A7\ /1 + A4
2 2 2i +2)
q n- + A4 q Xn-m Xq Xn-rn

n-rmXn
- 2 ~~+O(tri)
q Xn-m

since (1+A4/X2m>' -1-A4/X2_m+ * and both A7/X2 and A4/Xn2- are

O(n-12) i.p.
F =Fq,n-m + O(n-). (B.7)

The result in (B.7) gives us some confidencein employing F for our test
statistic;however,it must be recognizedthat thereis stillsome questionabout
the degreesoffreedomassociated withF in small samplessincein our procedure
2e is not an independentestimate of 2. The small-samplepropertiesof P
deserve furtherinvestigation.Finally, it is to be noted that since the prob-
ability limit of the errorin (B.7) is zero, qP will have the same asymptotic
distributionas qFq,nm, namely,a as indicated in part A of the Appendix.
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ceedingsoftheRoyal SocietyofEdinburgh,55 (1934-35), 42-8.
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[5] Cram6r,H., MathematicalMethodsof Statistics.Princeton: Princeton University
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368 AMERICAN STATISTICAL ASSOCIATION JOURNAL, JUNE 1962

[6] Grunfeld,Y., The Determinants of CorporateInvestment. UnpublishedPh.D. thesis

(Universityof Chicago, 1958).
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