Using Econometrics: A

Practical Guide
By A. H. Studenmund
Chapter 4
Lecture Notes prepared by:
Ishtiaq Ahmad
Department of Economics
The Islamia University of Bahawalpur

Ch No. 4
The Classical Model

What to learn here:

The Classical Assumptions
The Normal Distribution of the Error Term
The Sampling Distribution of
The Gauss Markov Theorem
Standard Econometric Notations

Classical Assumptions

What
is
meant
by
Classical
Model?
It has no concern with Greece or Adam Smiths Philosophy
but it simple means fulfillment of certain assumptions so
that estimator obtained by regression should be best and
unbiased.

Classical Assumptions

Linearity is required only in coefficients and

not in variables e.g.
taking log:
rearrange:

Model should be correctly specified and

should have additive error term

Hypothesis and Data

Collection

Hypothesize the expected signs of coefficients

Next step is data collection

Look for typographical and conceptual errors
All the variables must have same number of observations, same
frequency, and time period.
The general rule for sample size is that there should be as many
observations as possible (statistical concept of degree of freedom.
Degree of Freedom: Excess of the number of observations over the
number of coefficients to be estimated.
All conclusions about signs, significance and economic theory are
independent of unit of measurements e.g. in weight guessing
equation above, the estimation results when height is measured:
in inches above 5 feet:

In absolute height in inches:

Hypothesis and Data Collection

Estimation and Evaluation of

Reg

OLS is a standard estimation technique, however, where necessary

other fancy techniques could also be used.
After having estimation results:
it is better to check data errors:

to check the data transformations and outlier (an observation that lies outside the
range of rest of observations)
To make sure that the mean, maximum and minimum values of dataset are reasonable

Signs, magnitudes, significance and overall measure of fit should also

be evaluated
In case of problems additional model development or alternative
estimation technique may be required but any change in this regard
should be taken carefully.
It is worth noting that other estimation techniques are more sensitive
to data errors as compare to OLS, therefore, such techniques should
be avoided if there exist measurement errors in dataset.

Reporting the Results

Explanation of model, assumptions, procedures and dataset is

necessary part of results report.
Short definitions should also be explained along with the equations
of the model
In case of series of regression equations tables could also be used
for reporting the results.
In case that such an information is very large then appendix could
also be used for this purpose.
A standard format for regression results is as under:

() are used for standard error

Assignment
Section: 3.2 is an example of the six points
of applied regression analysis.
You select two different groups out of your
class.
Each group is assigned three point who then
explain these points through presentation.

Misuse of R2