06econometrics Statistics Basic 1-8

Basic Econometrics
Course Leader
Prof. Dr.Sc VuThieu
Prof.VuThieu
1
May 2004
Basic Econometrics
Introduction:
What is
Econometrics?
Prof.VuThieu
2
May 2004
Introduction
What is Econometrics?
Definition 1: Economic Measurement
Definition 2: Application of the
mathematical statistics to economic data

in order to lend empirical support to the
economic mathematical models and
obtain numerical results (Gerhard Tintner,
1968)
Prof.VuThieu
3
May 2004
Introduction
Definition 3: The quantitative
analysis of actual economic phenomena

based on concurrent development of
theory and observation, related by
appropriate methods of inference
(P.A.Samuelson, T.C.Koopmans and

J.R.N.Stone, 1954)
Prof.VuThieu
4
May 2004
Introduction
Definition 4: The social science
which applies economics, mathematics

and statistical inference to the analysis of
economic phenomena (By Arthur S.
Goldberger, 1964)
Definition 5: The empirical
determination of economic laws (By H.

Theil, 1971)
Prof.VuThieu
5
May 2004
Introduction
Definition 6: A conjunction of
economic theory and actual
measurements, using the theory and
technique of statistical inference as a
bridge pier (By T.Haavelmo, 1944)
And the others
Prof.VuThieu
6
May 2004
Economic
Theory
Mathematical
Economics
Econometrics
Economic
Statistics
Prof.VuThieu
Mathematic
Statistics
7
May 2004
Introduction
Why a separate
Economic theory
discipline
?
makes statements
that are mostly qualitative in nature,
while econometrics gives empirical
content to most economic theory
Mathematical economics is to
express economic theory in

mathematical form without empirical
verification of the theory, while
econometrics is mainly interested in the
later
Prof.VuThieu
8
May 2004
Introduction
Why a separate discipline?
Economic Statistics is mainly
concerned with collecting, processing

and presenting economic data. It does
not being concerned with using the
collected data to test economic theories
Mathematical statistics provides
many of tools for economic studies, but

econometrics supplies the later with
many special methods of quantitative
analysis based on economic data
Prof.VuThieu
9
May 2004
Economic
Theory
Mathematical
Economics
Econometrics
Economic
Statistics
Prof.VuThieu
Mathematic
Statistics
10
May 2004
Introduction
Methodology of
(1) Statement of theory or
Econometrics
hypothesis:
Keynes stated: Consumption
increases as income increases, but
not as much as the increase in
income. It means that The
marginal propensity to consume
(MPC) for a unit change in
income is grater than zero but less
than unit
Prof.VuThieu
11
May 2004
Introduction
Methodology of
(2)
Specification of the
Econometrics
mathematical model of the

theory
Y = 1+ 2X ; 0 < 2< 1
Y= consumption expenditure
X= income
1 and 2 are parameters; 1 is

intercept, and 2 is slope coefficients
Prof.VuThieu
12
May 2004
Introduction
Methodology of
(3)
Specification of the
Econometrics
econometric model of the

theory
Y = 1+ 2X + u ; 0 < 2< 1;
Y = consumption expenditure;
X = income;
1 and 2 are parameters; 1is

intercept and 2 is slope coefficients;
u is disturbance term or error term. It
is a random or stochastic variable
Prof.VuThieu
13
May 2004
Introduction
Methodology of
Econometrics
(4) Obtaining Data
(See Table 1.1, page 6)
Y= Personal consumption
expenditure
X= Gross Domestic Product
all in Billion US Dollars
Prof.VuThieu
14
May 2004
Introduction
Methodology of
(4)
Obtaining
Data
Econometrics
Year
X
Prof.VuThieu
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
2447.1
2476.9
2503.7
2619.4
2746.1
2865.8
2969.1
3052.2
3162.4
3223.3
3260.4
3240.8
3776.3
3843.1
3760.3
3906.6
4148.5
4279.8
4404.5
4539.9
4718.6
4838.0
4877.5
4821.0
15
May 2004
Introduction
Methodology of
(5) Econometrics
Estimating the Econometric
Model
Y^ = - 231.8 + 0.7194 X (1.3.3)

MPC was about 0.72 and it means
that for the sample period when real
income increases 1 USD, led (on
average) real consumption
expenditure increases of about 72
cents
Note: A hat symbol (^) above one
16
variable
will
signify
an
estimator
of
the
Prof.VuThieu
May 2004
relevant population value
Introduction
Methodology of
Econometrics
(6)
Hypothesis Testing
Are the estimates accord with the

expectations of the theory that is being
tested? Is MPC < 1 statistically? If so,
it may support Keynes theory.
Confirmation or refutation of
economic theories based on
sample evidence is object of Statistical
Inference (hypothesis testing)
Prof.VuThieu
17
May 2004
Introduction
Methodology of
(7)Econometrics
Forecasting or Prediction
With given future value(s) of X, what

is the future value(s) of Y?
GDP=$6000Bill in 1994, what is the
forecast consumption expenditure?
Y^= - 231.8+0.7196(6000) = 4084.6
Income Multiplier M = 1/(1 MPC)
(=3.57). decrease (increase) of $1 in
investment will eventually lead to
$3.57 decrease (increase) in income
Prof.VuThieu
18
May 2004
Introduction
Methodology of
Econometrics
(8) Using model for control or
policy purposes
Y=4000= -231.8+0.7194 X X 5882
MPC = 0.72, an income of $5882 Bill
will produce an expenditure of $4000
Bill. By fiscal and monetary policy,
Government can manipulate the
control variable X to get the desired
level of target variable Y
Prof.VuThieu
19
May 2004
Introduction
Methodology of
Econometrics
Figure
1.4: Anatomy of economic
modelling
1) Economic Theory
2) Mathematical Model of Theory
3) Econometric Model of Theory
4) Data
5) Estimation of Econometric Model
6) Hypothesis Testing
7) Forecasting or Prediction
8) Using the Model for control or policy
purposes
Prof.VuThieu
20
May 2004
Economic Theory
Mathematic Model
Econometric Model
Data Collection
Estimation
Hypothesis Testing
Forecasting
Prof.VuThieu
Application
in control or
policy
studies
21
May 2004
Basic Econometrics
Chapter 1:
THE NATURE OF
REGRESSION
ANALYSIS
Prof.VuThieu
22
May 2004
1-1. Historical origin of the term

Regression
The
term REGRESSION was

introduced by Francis Galton
Tendency for tall parents to have tall
children and for short parents to have
short children, but the average height of
children born from parents of a given
height tended to move (or regress)
toward the average height in the
population as a whole (F. Galton,
Family Likeness in Stature)
Prof.VuThieu
23
May 2004
1-1. Historical origin of the term

Regression
Galtons
Law was confirmed by Karl

Pearson: The average height of sons of
a group of tall fathers < their fathers
height. And the average height of sons
of a group of short fathers > their
fathers height. Thus regressing tall
and short sons alike toward the average
height of all men. (K. Pearson and A.
Lee, On the law of Inheritance)
By the words of Galton, this was
Regression to mediocrity
Prof.VuThieu
24
May 2004
1-2. Modern Interpretation of

Regression Analysis
Prof.VuThieu
The modern way in interpretation of

Regression: Regression Analysis is
concerned with the study of the
dependence of one variable (The
Dependent Variable), on one or more
other variable(s) (The Explanatory
Variable), with a view to estimating
and/or predicting the (population)
mean or average value of the former in
term of the known or fixed (in
repeated sampling) values of the latter.
25
Examples: (pages 16-19)
May 2004
Dependent Variable Y; Explanatory Variable Xs

1. Y = Sons Height; X = Fathers Height
2. Y = Height of boys; X = Age of boys
3. Y = Personal Consumption Expenditure
X = Personal Disposable Income
4. Y = Demand; X = Price
5. Y = Rate of Change of Wages
X = Unemployment Rate
6. Y = Money/Income; X = Inflation Rate
7. Y = % Change in Demand; X = % Change in the
advertising budget
8. Y = Crop yield; Xs = temperature, rainfall, sunshine,
fertilizer
Prof.VuThieu
26
May 2004
1-3. Statistical vs.

Deterministic
Relationships
In regression analysis we are concerned
with STATISTICAL DEPENDENCE
among variables (not Functional or
Deterministic), we essentially deal with
RANDOM or STOCHASTIC variables
(with the probability distributions)
Prof.VuThieu
27
May 2004
1-4. Regression vs. Causation:

Regression does not necessarily imply
causation. A statistical relationship
cannot logically imply causation. A
statistical relationship, however strong
and however suggestive, can never
establish causal connection: our ideas
of causation must come from outside
statistics, ultimately from some theory
or other (M.G. Kendal and A. Stuart,
The Advanced Theory of Statistics)
Prof.VuThieu
28
May 2004
1-5. Regression vs.

Correlation
Correlation Analysis:
the primary objective

is to measure the strength or degree of
linear association between two variables
(both are assumed to be random)
Regression Analysis: we try to estimate or
predict the average value of one variable
(dependent, and assumed to be stochastic)
on the basis of the fixed values of other
variables (independent, and non-stochastic)
Prof.VuThieu
29
May 2004
1-6. Terminology and Notation

Dependent Variable
Explained Variable
Predictand
Regressand
Response
Endogenous
Prof.VuThieu
Explanatory
Variable(s)
Independent
Variable(s)
Predictor(s)
Regressor(s)
Stimulus or control
variable(s)
Exogenous(es)
30
May 2004
1-7. The Nature and Sources

of Data for Econometric
Analysis
1) Types of Data :
Time series data;
Cross-sectional data;
Pooled data
2) The Sources of Data
3) The Accuracy of Data
Prof.VuThieu
31
May 2004
1-8. Summary and Conclusions

1) The key idea behind regression
analysis is the statistic dependence of
one variable on one or more other
variable(s)
2) The objective of regression analysis is
to estimate and/or predict the mean or
average value of the dependent
variable on basis of known (or fixed)
values of explanatory variable(s)
Prof.VuThieu
32
May 2004

3) The success of regression depends on
the available and appropriate data
4) The researcher should clearly state the
sources of the data used in the
analysis, their definitions, their
methods of collection, any gaps or
omissions and any revisions in the data
Prof.VuThieu
33
May 2004
Basic Econometrics
Chapter 2:
TWO-VARIABLE
REGRESSION ANALYSIS:
Some basic Ideas
Prof.VuThieu
34
May 2004
2-1. A Hypothetical Example

Total
population: 60 families
Y=Weekly family consumption expenditure
X=Weekly disposable family income
60 families were divided into 10 groups of
approximately the same income level
(80, 100, 120, 140, 160, 180, 200, 220, 240, 260)
Prof.VuThieu
35
May 2004

Table
2-1 gives the conditional distribution

of Y on the given values of X
Table 2-2 gives the conditional probabilities
of Y: p(Y X)
Conditional Mean
(or Expectation): E(Y X=Xi )
Prof.VuThieu
36
May 2004
Table 2-2: Weekly family income X ($),

X
Y
Weekly
family
consumption
expenditure
Y ($)
and consumption Y ($)
80 100 120 140 160 180 200 220 240 260

55
60
65
70
75
---
65
70
74
80
85
88
--
79
84
90
94
98
---
80
93
95
103
108
113
115
102
107
110
116
118
125
--
110
115
120
130
135
140
--
120
136
140
144
145
---
135
137
140
152
157
160
162
137
145
155
165
175
189
--
150
152
175
178
180
185
191
Total
325 462 445 707 678 750 685 1043 966 1211
Mean
65
Prof.VuThieu
77
89
101 113 125 137 149
161 173
37
May 2004

Figure
2-1 shows the population

regression line (curve). It is the
regression of Y on X
Population regression curve is the
locus of the conditional means or
expectations of the dependent variable
for the fixed values of the explanatory
variable X (Fig.2-2)
Prof.VuThieu
38
May 2004
2-2. The concepts of population

regression function (PRF)
E(Y
X=Xi ) = f(Xi) is Population

Regression Function (PRF) or
Population Regression (PR)
In the case of linear function we have
linear population regression function (or
equation or model)
E(Y X=Xi ) = f(Xi) = 1 + 2Xi
Prof.VuThieu
39
May 2004
2-2. The concepts of population

regression function (PRF)
E(Y X=Xi ) = f(Xi) = 1 + 2Xi
1 and 2 are regression coefficients, 1is
intercept and 2 is slope coefficient
Linearity in the Variables
Linearity in the Parameters
Prof.VuThieu
40
May 2004
2-4. Stochastic Specification of PRF

Ui
= Y - E(Y X=Xi ) or Yi = E(Y X=Xi ) + Ui

Ui = Stochastic disturbance or stochastic error
term. It is nonsystematic component
Component E(Y X=Xi ) is systematic or
deterministic. It is the mean consumption
expenditure of all the families with the same
level of income
The assumption that the regression line
passes through the conditional means of Y
implies that E(Ui Xi ) = 0
Prof.VuThieu
41
May 2004
2-5. The Significance of the Stochastic

Term
Ui =Disturbance
Stochastic Disturbance
Term is a
surrogate for all variables that are
omitted from the model but they
collectively affect Y
Many reasons why not include such
variables into the model as follows:
Prof.VuThieu
42
May 2004
2-5. The Significance of the Stochastic

WhyDisturbance
not include asTerm
many as variable into
the model (or the reasons for using u i)
+ Vagueness of theory
+ Unavailability of Data
+ Core Variables vs. Peripheral Variables
+ Intrinsic randomness in human behavior
+ Poor proxy variables
+ Principle of parsimony
+ Wrong functional form
Prof.VuThieu
43
May 2004
2-6. The Sample Regression

Function
(SRF)
Table 2-4: A random
sample from the
population
YX
-----------------70 80
65 100
90 120
95 140
110 160
115 180
120 200
140 220
155 240
150 260
------------------
Prof.VuThieu
Table 2-5: Another random

sample from the population
Y
X
------------------55 80
88 100
90 120
80 140
118 160
120 180
145 200
135 220
145 240
175 260
--------------------
44
May 2004
Weekly Consumption
Expenditure (Y)
SRF1
SRF2
Prof.VuThieu
Weekly Income (X)
45
May 2004

Function (SRF)
Fig.2-3:
SRF1 and SRF 2

Yî = ^1 + ^2Xi
(2.6.1)
Yî = estimator of E(Y Xi)
^1 = estimator of 1
^2 = estimator of 2
Estimate = A particular numerical value
obtained by the estimator in an application
SRF in stochastic form: Yi= ^1 + ^2Xi + uî
or Yi= Yî + uî (2.6.3)
Prof.VuThieu
46
May 2004

Function (SRF)
Primary objective in regression analysis is

to estimate the PRF Yi= 1 + 2Xi + ui on
the basis of the SRF Yi= ^1 + ^2Xi + ei
and how to construct SRF so that ^1 close
to 1 and ^2 close to 2 as much as
possible
Prof.VuThieu
47
May 2004

Function (SRF)
Population
Regression Function PRF

Linearity in the parameters
Stochastic PRF
Stochastic Disturbance Term u i plays a
critical role in estimating the PRF
Sample of observations from population
Stochastic Sample Regression Function
SRF used to estimate the PRF
Prof.VuThieu
48
May 2004

The
key concept underlying regression

analysis is the concept of the
population regression function (PRF).
This book deals with linear PRFs:
linear in the unknown parameters.
They may or may not linear in the
variables.
Prof.VuThieu
49
May 2004

For
empirical purposes, it is the stochastic

PRF that matters. The stochastic
disturbance term ui plays a critical role in
estimating the PRF.
The PRF is an idealized concept, since in
practice one rarely has access to the entire
population of interest. Generally, one has a
sample of observations from population
and use the stochastic sample regression
(SRF) to estimate the PRF.
Prof.VuThieu
50
May 2004
Basic Econometrics
Chapter 3:
TWO-VARIABLE
REGRESSION MODEL:
The problem of Estimation
Prof.VuThieu
51
May 2004
3-1. The method of ordinary

least square (OLS)
Least-square criterion:
Minimizing U^2i = (Yi Yî) 2
= (Yi- ^1 - ^2X)2
(3.1.2)
Normal Equation and solving it
for ^1 and ^2 = Least-square
estimators [See (3.1.6)(3.1.7)]
Numerical and statistical

properties of OLS are as follows:
Prof.VuThieu
52
May 2004
3-1. The method of ordinary least

square (OLS)
OLS estimators are expressed solely in terms of
observable quantities. They are point estimators
The sample regression line passes through
sample means of X and Y
The mean value of the estimated Y^ is equal to
the mean value of the actual Y: E(Y) = E(Y^)
The mean value of the residuals Uî is zero:
E(uî )=0
uî are uncorrelated with the predicted Yî and
with Xi : That are uîYî = 0; uîXi = 0
Prof.VuThieu
53
May 2004
3-2. The assumptions underlying

the method of least squares
Ass
1: Linear regression model

(in parameters)
Ass 2: X values are fixed in repeated
sampling
Ass 3: Zero mean value of ui : E(ui Xi)=0
Ass 4: Homoscedasticity or equal
variance of ui : Var (ui Xi) = 2
[VS. Heteroscedasticity]
Ass 5: No autocorrelation between the
disturbances: Cov(ui,uj Xi,Xj ) = 0
with i # j [VS. Correlation, + or - ]
Prof.VuThieu
54
May 2004
3-2. The assumptions underlying

the method of least squares
Ass 6: Zero covariance between ui and Xi
Cov(ui, Xi) = E(ui, Xi) = 0
Ass 7: The number of observations n must be
greater than the number of parameters
to be estimated
Ass 8: Variability in X values. They must
not all be the same
Ass 9: The regression model is correctly
specified
Ass 10: There is no perfect multicollinearity
between Xs
Prof.VuThieu
55
May 2004
3-3. Precision or standard errors of

least-squares estimates
In
statistics the precision of an

estimate is measured by its standard
error (SE)
var( ^2) = 2 / x2i
(3.3.1)
se(^2) = Var(^2)
(3.3.2)
var( ^1) = 2 X2i / n x2i
(3.3.3)
se(^1) = Var(^1)
(3.3.4)
^ 2 = u^2i / (n - 2)
(3.3.5)
^ = ^ 2 is standard error of the
56
Prof.VuThieu
estimate
May 2004
3-3. Precision or standard errors of

least-squares estimates
Features of the variance:
+ var( ^2) is proportional to 2 and
inversely proportional to x2i
+ var( ^1) is proportional to 2 and

X2i but inversely proportional to x2i
and the sample size n.
X
+ cov ( ^1 , ^2) = - var( ^2) shows
the independence between ^1 and ^2
Prof.VuThieu
57
May 2004
3-4. Properties of least-squares

estimators: The Gauss-Markov Theorem
An OLS estimator is said to be BLUE if :
+ It is linear, that is, a linear function of a
random variable, such as the dependent
variable Y in the regression model
+ It is unbiased , that is, its average or expected
value, E(^2), is equal to the true value 2
+ It has minimum variance in the class of all
such linear unbiased estimators
An unbiased estimator with the least variance is
known as an efficient estimator
Prof.VuThieu
58
May 2004
3-4. Properties of least-squares

estimators: The Gauss-Markov
Theorem
Gauss- Markov Theorem:
Given the assumptions of the
classical linear regression model,
the least-squares estimators, in
class of unbiased linear estimators,
have minimum variance, that is,
they are BLUE
Prof.VuThieu
59
May 2004
3-5. The coefficient of determination

r2: A measure of Goodness of fit
i + U i or
Yi = Y
Y
Y
Yi - = i - i +
y
U
yi = i + i
(Note:
or
Y=Y
)
Squaring on both side and summing =>
2
22 x2 +
yi2 =
i
i ; or
TSS = ESS + RSS

Prof.VuThieu
60
May 2004
3-5. The coefficient of determination r2:

A measure of Goodness of fit
TSS = yi2 = Total Sum of Squares
ESS = Y^ i2 = ^22 x2i =

Explained Sum of Squares
RSS = u^2I = Residual Sum of
Squares
ESS
RSS
1 = -------- + -------- ; or
TSS
TSS
1=
Prof.VuThieu
RSS
r2 + ------- ;
TSS
RSS
or r2 = 1 - ------TSS
61
May 2004

r2 = ESS/TSS
is coefficient of determination, it measures
the proportion or percentage of the total
variation in Y explained by the regression
Model
0 r2 1;
r = r2 is sample correlation
coefficient
Some properties of r
Prof.VuThieu
62
May 2004

3-6. A numerical Example (pages 80-83)
3-7. Illustrative Examples (pages 83-85)
3-8. Coffee demand Function
3-9. Monte Carlo Experiments (page 85)
3-10. Summary and conclusions (pages
86-87)
Prof.VuThieu
63
May 2004
Basic Econometrics
Chapter 4:
THE NORMALITY
ASSUMPTION:
Classical Normal Linear
Regression Model
(CNLRM)
Prof.VuThieu
64
May 2004
4-2.The normality assumption

CNLR
assumes that each u i is distributed

normally u i N(0, 2) with:
Mean
= E(u i) = 0 Ass 3
Variance
= E(u2i) = 2 Ass 4
Cov(u i , u j ) = E(u i , u j) = 0 (i#j)
Ass 5
Note: For two normally distributed variables, the
zero covariance or correlation means
independence of them, so u i and u j are not only
uncorrelated but also independently distributed.
Therefore u i NID(0, 2) is Normal and
Independently Distributed
Prof.VuThieu
65
May 2004
(1)
(2)
Prof.VuThieu
Why the normality assumption?

With a few exceptions, the distribution of sum
of a large number of independent and
identically distributed random variables tends
to a normal distribution as the number of
such variables increases indefinitely
If the number of variables is not very large or
they are not strictly independent, their sum
may still be normally distributed
66
May 2004
(3)
(4)
Prof.VuThieu
Why the normality assumption?

Under the normality assumption
for ui , the OLS estimators ^1 and
^2 are also normally distributed
The normal distribution is a
comparatively simple distribution
involving only two parameters
(mean and variance)
67
May 2004
4-3. Properties of OLS

estimators under the normality
assumption
With the normality assumption the

OLS estimators ^1 , ^2 and ^2 have
the following properties:
1. They are unbiased
2. They have minimum variance.
Combined 1 and 2, they are efficient
estimators
3. Consistency, that is, as the sample size
increases indefinitely, the estimators
converge to their true population
values
Prof.VuThieu
68
May 2004
4-3. Properties of OLS estimators

under the normality assumption
4. ^1 is normally distributed
N( 1, ^12)
And Z = (^1- 1)/ ^1 is N(0,1)
5. ^2 is normally distributed N( 2 ,^22)
And Z = (^2- 2)/ ^2 is N(0,1)
6. (n-2) ^2/ 2 is distributed as the
2(n-2)
Prof.VuThieu
69
May 2004
4-3. Properties of OLS estimators

under the normality assumption
7. ^1 and ^2 are distributed
independently of ^2. They have
minimum variance in the entire class
of unbiased estimators, whether linear
or not. They are best unbiased
estimators (BUE)
8. Let ui is N(0, 2 ) then Yi is
N[E(Yi); Var(Yi)] = N[ 1+ 2X i ; 2]
Prof.VuThieu
70
May 2004
Some last points of chapter 4

4-4. The method of Maximum likelihood (ML)
ML is point estimation method with some
stronger theoretical properties than OLS
(Appendix 4.A on pages 110-114)
The estimators of coefficients s by OLS and ML are
identical. They are true estimators of the s
(ML estimator of 2) = uî2/n (is biased estimator)
(OLS estimator of 2) = uî2/n-2 (is unbiased
estimator)
When sample size (n) gets larger the two estimators
tend to be equal
Prof.VuThieu
71
May 2004
Some last points of chapter 4

4-5. Probability distributions related
to the Normal Distribution: The t, 2,
and F distributions
See section (4.5) on pages 107-108
with 8 theorems and Appendix A, on
pages 755-776
See 10 conclusions on pages 109-110
Prof.VuThieu
72
May 2004
Basic Econometrics
Chapter 5:
TWO-VARIABLE
REGRESSION:
Interval Estimation
and Hypothesis Testing
Prof.VuThieu
73
May 2004
Chapter 5 TWO-VARIABLE REGRESSION:

Interval Estimation and Hypothesis Testing
5-1. Statistical Prerequisites

See Appendix A with
key concepts
such as probability, probability
distributions, Type I Error, Type II
Error,level of significance, power of a
statistic test, and confidence interval
Prof.VuThieu
74
May 2004

5-2. Interval estimation: Some basic Ideas

How
close is, say, ^2 to 2 ?
Pr (^2 - 2 ^2 + ) = 1 -
Random
(5.2.1)
interval ^2 - 2 ^2 +
if exits, it known as confidence interval

^2
- is lower confidence limit
^2 +
Prof.VuThieu
is upper confidence limit

75
May 2004


(1
0
- ) is confidence coefficient,
< < 1 is significance level
Equation
(5.2.1) does not mean that the Pr of

2 lying between the given limits is (1 - ), but
the Pr of constructing an interval that contains
2 is (1 - )
(^2
Prof.VuThieu
- , ^2 + ) is random interval
76
May 2004


In
repeated sampling, the intervals will

enclose, in (1 - )*100 of the cases, the true
value of the parameters
For a specific sample, can not say that the
probability is (1 - ) that a given fixed interval
includes the true 2
If the sampling or probability distributions of
the estimators are known, one can make
confidence interval statement like (5.2.1)
Prof.VuThieu
77
May 2004

5-3. Confidence Intervals for Regression

Coefficients
Z=
(^2 - 2)/se(^2) = (^2 - 2) x2i / ~N(0,1)
(5.3.1)
We did not know and have to use ^ instead, so:
t=
(^2 - 2)/se(^2) = (^2 - 2) x2i /^ ~ t(n-2)
=>
Interval for 2
Pr [ -t /2 t t /2] = 1-
Prof.VuThieu
(5.3.2)
(5.3.3)
78
May 2004

5-3. Confidence Intervals for Regression

Coefficients
Or
confidence interval for 2 is
Pr [^2-t /2se(^2) 2 ^2+t /2se(^2)] = 1-

Confidence
Interval for 1
(5.3.5)
Pr [^1-t /2se(^1) 1 ^1+t /2se(^1)] = 1-

(5.3.7)
Prof.VuThieu
79
May 2004

5-4. Confidence Intervals for 2

Pr [(n-2)^2/ 2/2 2 (n-2)^2/ 21- /2] = 1-
(5.4.3)
The
interpretation of this interval is: If we

establish (1- ) confidence limits on 2
and if we maintain a priori that these
limits will include true 2, we shall be
right in the long run (1- ) percent of the
time
Prof.VuThieu
80
May 2004

5-5. Hypothesis Testing: General Comments

The stated hypothesis is known as the
null hypothesis: Ho
The Ho is tested against and alternative
hypothesis: H1
5-6. Hypothesis Testing: The confidence

interval approach
One-sided or one-tail Test

H0: 2 * versus H1: 2 > *
Prof.VuThieu
81
May 2004

Two-sided or two-tail Test

H0: 2 = * versus H1: 2 # *
^2 - t /2se(^2) 2 ^2 + t /2se(^2) values
of 2 lying in this interval are plausible under Ho
with 100*(1- )% confidence.
If 2 lies in this region we do not reject Ho (the
finding is statistically insignificant)
If 2 falls outside this interval, we reject Ho (the
finding is statistically significant)
Prof.VuThieu
82
May 2004

5-7. Hypothesis Testing:

The test of significance approach
A test of significance is a procedure by
which sample results are used to verify the
truth or falsity of a null hypothesis
Testing the significance of regression
coefficient: The t-test
Pr [^2-t /2se(^2) 2 ^2+t /2se(^2)]= 1-
(5.7.2)
Prof.VuThieu
83
May 2004

5-7.
Hypothesis Testing: The test of

significance approach
Table 5-1: Decision Rule for t-test of significance
Type of
Hypothesis
H0
H1
Reject H0
if
Two-tail
2 = 2*
2 # 2*
|t| > t/2,df
Right-tail
2 2*
2 > 2*
t > t,df
Left-tail
2 2*
2 < 2*
t < - t,df
Prof.VuThieu
84
May 2004

5-7.

Testing the significance of 2 : The 2 Test
Under the Normality assumption we have:
^2
2 = (n-2) ------- ~ 2 (n-2)
2
(5.4.1)
From (5.4.2) and (5.4.3) on page 520 =>
Prof.VuThieu
85
May 2004

5-7.

Table 5-2: A summary of the 2 Test
H0
H1
Reject H0 if
2 = 20
2 > 20
Df.(^2)/ 20 > 2 ,df
2 = 20
2 < 20
Df.(^2)/ 20 < 2(1-),df
2 = 20
2 # 20
Df.(^2)/ 20 > 2/2,df

or < 2 (1-/2), df
Prof.VuThieu
86
May 2004


Some practical aspects
1) The meaning of Accepting or
Rejecting a Hypothesis
2) The Null Hypothesis and the Rule of
Thumb
3) Forming the Null and Alternative
Hypotheses
4) Choosing , the Level of Significance
Prof.VuThieu
87
May 2004


Some practical aspects
5) The Exact Level of Significance:
The p-Value [See page 132]
6) Statistical Significance versus
Practical Significance
7) The Choice between ConfidenceInterval and Test-of-Significance
Approaches to Hypothesis Testing
Prof.VuThieu
[Warning: Read carefully pages 117-134 ]
88
May 2004

5-9. Regression Analysis and Analysis

of Variance
TSS = ESS + RSS
F=[MSS of ESS]/[MSS of RSS] =
= 2^2 xi2/ ^2
(5.9.1)
If ui are normally distributed; H 0: 2 = 0
then F follows the F distribution with 1
and n-2 degree of freedom
Prof.VuThieu
89
May 2004

5-9.
Regression Analysis and

Analysis of Variance
F provides a test statistic to test the
null hypothesis that true 2 is zero by

compare this F ratio with the F-critical
obtained from F tables at the chosen
level of significance, or obtain the pvalue of the computed F statistic to
make decision
Prof.VuThieu
90
May 2004

5-9.
Regression Analysis and Analysis

of Variance
Table 5-3. ANOVA for two-variable regression model
Source of
Variation
Sum of square ( SS)
Degree of
Freedom (Df)
ESS (due to
regression)
yî2 = 2^2 xi2
RSS (due to
residuals)
uî2
n-2
TSS
y i2
n-1
Prof.VuThieu
Mean sum of
square ( MSS)
2^2 xi2
uî2 /(n-2)= ^2
91
May 2004

5-10. Application of Regression

Analysis: Problem of Prediction
By the data of Table 3-2, we obtained the

sample regression (3.6.2) :
Yî = 24.4545 + 0.5091X i , where
Yî is the estimator of true E(Yi)
There are two kinds of prediction as
follows:
Prof.VuThieu
92
May 2004

5-10. Application of Regression

Analysis: Problem of Prediction
Mean prediction: Prediction of the

conditional mean value of Y
corresponding to a chosen X, say X 0, that
is the point on the population regression
line itself (see pages 137-138 for details)
Individual prediction: Prediction of an
individual Y value corresponding to X 0
(see pages 138-139 for details)
Prof.VuThieu
93
May 2004

5-11. Reporting the results of

regression analysis
An illustration:
YÎ= 24.4545 + 0.5091Xi

Se = (6.4138) (0.0357)
t = (3.8128) (14.2405)
P = (0.002517) (0.000000289)
Prof.VuThieu
(5.1.1)
r2= 0.9621
df= 8
F1,2=2202.87
94
May 2004

5-12. Evaluating the results of regression

analysis:
Normality Test: The Chi-Square ( 2)
Goodness of fit Test
2N-1-k = (Oi Ei)2/Ei (5.12.1)
Oi is observed residuals (uî) in interval i

Ei is expected residuals in interval i
N is number of classes or groups; k is number of
parameters to be estimated. If p-value of
obtaining 2N-1-k is high (or 2N-1-k is small) =>
95
The
Normality
Hypothesis
can
not
be
rejected
Prof.VuThieu
May 2004


analysis:
Normality Test: The Chi-Square ( 2)
Goodness of fit Test
H0: ui is normally distributed
H1: ui is un-normally distributed
Calculated- 2N-1-k = (Oi Ei)2/Ei
(5.12.1)
Decision rule:
Calculated- 2N-1-k > Critical- 2N-1-k then H0 can
be rejected
Prof.VuThieu
96
May 2004


analysis:
The Jarque-Bera (JB) test of normality
This test first computes the Skewness (S)
and Kurtosis (K) and uses the following
statistic:
JB = n [S2/6 + (K-3)2/24]
(5.12.2)
Mean= xbar = xi/n ; SD2 = (xi-xbar)2/(n-1)
S=m3/m2 3/2 ; K=m4/m22 ; mk= (xi-xbar)k/n
Prof.VuThieu
97
May 2004

5-12. (Continued)
Under the null hypothesis H0 that the
residuals are normally distributed Jarque
and Bera show that in large sample
(asymptotically) the JB statistic given in
(5.12.12) follows the Chi-Square
distribution with 2 df. If the p-value of
the computed Chi-Square statistic in an
application is sufficiently low, one can
reject the hypothesis that the residuals
are normally distributed. But if p-value is
reasonable high, one does not reject the
normality assumption.
Prof.VuThieu
98
May 2004


1.
Estimation and Hypothesis testing

constitute the two main branches of
classical statistics
2. Hypothesis testing answers this
question: Is a given finding compatible
with a stated hypothesis or not?
3. There are two mutually complementary
approaches to answering the preceding
question: Confidence interval and test of
significance.
Prof.VuThieu
99
May 2004


4. Confidence-interval approach has a
specified probability of including
within its limits the true value of the
unknown parameter. If the nullhypothesized value lies in the
confidence interval, H0 is not rejected,
whereas if it lies outside this interval,
H0 can be rejected
Prof.VuThieu
100
May 2004


5. Significance test procedure develops a test
statistic which follows a well-defined
probability distribution (like normal, t, F, or
Chi-square). Once a test statistic is
computed, its p-value can be easily
obtained.
Prof.VuThieu
The p-value The p-value of a test is the

lowest significance level, at which we
would reject H0. It gives exact probability
of obtaining the estimated test statistic
under H0. If p-value is small, one can reject
H0, but if it is large one may not reject H0. 101
May 2004


6. Type I error is the error of
rejecting a true hypothesis. Type II
error is the error of accepting a
false hypothesis. In practice, one
should be careful in fixing the level
of significance , the probability of
committing a type I error (at
arbitrary values such as 1%, 5%,
10%). It is better to quote the pvalue of the test statistic.
102
Prof.VuThieu
May 2004


7. This chapter introduced the
normality test to find out whether
ui follows the normal distribution.
Since in small samples, the t,
F,and Chi-square tests require the
normality assumption, it is
important that this assumption
be checked formally
Prof.VuThieu
103
May 2004

5-13. Summary and

Conclusions (ended)
8. If the model is deemed
practically adequate, it may be
used for forecasting purposes.
But should not go too far out of
the sample range of the
regressor values. Otherwise,
forecasting errors can increase
104
dramatically.
Prof.VuThieu
May 2004
Basic Econometrics
Chapter 6
EXTENSIONS OF THE
TWO-VARIABLE LINEAR
REGRESSION MODEL
Prof.VuThieu
105
May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE LINEAR
REGRESSION MODELS
6-1. Regression through the origin

The SRF form of regression:
Yi = ^2X i + u^ i
(6.1.5)
Comparison two types of regressions:

* Regression through-origin model and
* Regression with intercept
Prof.VuThieu
106
May 2004
Chapter 6
REGRESSION MODELS

Comparison two types of regressions:
^2 = XiYi/X2i
^2 = xiyi/x2i
var(^2) = 2/X2i
var(^2) = 2/x2i
^2 = uî)2/(n-1)
Prof.VuThieu
^2 = u^ )2/(n-2)
(6.1.6)
(3.1.6)
(6.1.7)
(3.3.1)
(6.1.8)
(3.3.5)
O
I
O
I
O
I
107
May 2004
Chapter 6
REGRESSION MODELS
r2 for regression through-origin model
Raw r2 = (XiYi)2 /X2iY2i (6.1.9)
Note: Without very strong a priory expectation, well

advise is sticking to the conventional, interceptpresent 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
Prof.VuThieu
108
May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE
LINEAR REGRESSION MODELS

Illustrative Examples:
1) Capital Asset Pricing Model - CAPM (page 156)
2) Market Model
(page 157)
3) The Characteristic Line of Portfolio Theory
(page 159)
Prof.VuThieu
109
May 2004
Chapter 6
REGRESSION MODELS
6-2. Scaling and units of measurement
Let Yi = ^1 + ^2Xi + u^ i
(6.2.1)
Define Y*i=w 1 Y i and X*i=w 2 X i then:
^2 = (w1/w2)^2
(6.2.15)
^1 = w1^1
(6.2.16)
*^2 = w12^2
(6.2.17)
Var(^1) = w21 Var(^1)
(6.2.18)
Var(^2) = (w1/w2)2 Var(^2)
(6.2.19)
110
2
2
rProf.VuThieu
=
r
(6.2.20)
May 2004
xy
x*y*
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE
LINEAR REGRESSION MODELS
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
Prof.VuThieu
Estimators
111
May 2004
6-3. Functional form of regression model

The log-linear model
Semi-log model
Reciprocal model
Prof.VuThieu
112
May 2004
6-4. How to measure elasticity

Exponential regression model:

Yi= 1Xi e u i
(6.4.1)
By taking log to the base e of both side:

lnYi = ln 1 + 2lnXi + ui , by setting ln 1 =
lnYi = + 2lnXi + ui
(6.4.3)
(log-log, or double-log, or log-linear model)
This can be estimated by OLS by letting
Y*i = + 2X*i + ui , where Y*i=lnYi, X*i=lnXi ;
2 measures the ELASTICITY of Y respect to X, that is,

113
Prof.VuThieu
percentage
change in Y for a given (small) percentage May 2004
6-4. How to measure elasticity
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 (pages 167-168)
Prof.VuThieu
114
May 2004
6-5. Semi-log model:

Log-lin and Lin-log Models
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 = + 2t , called constant growth model (6.5.5)
where 1 = lnY0 ; 2 = ln(1+r)
lnYt = + 2t + 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)
2 = (Relative change in regressand)/(Absolute change
in regressor)
(6.5.7)
Prof.VuThieu
115
May 2004

Instantaneous Vs. compound rate of growth

2 is instantaneous rate of growth
antilog( 2) 1 is compound rate of growth
The linear trend model
Yt = + 2t + ut
(6.5.9)
If 2 > there is an upward trend in Y
If 2 < 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.
116
Prof.VuThieu
May 2004

The lin-log model:

Yi = 1 + 2lnXi + ui
(6.5.11)
2 = (Change in Y) / Change in lnX =

(Change in Y)/(Relative change in X) ~
(Y)/(X/X)
(6.5.12)
or Y = 2 (X/X)
(6.5.13)
That is, the absolute change in Y equal
to 2 times the relative change in X.
Prof.VuThieu
117
May 2004
6-6. Reciprocal Models:

The reciprocal model:

Yi = 1 + 2( 1/Xi ) + ui (6.5.14)
As X increases definitely, the term

2( 1/Xi ) approaches to zero and Yi
approaches the limiting or asymptotic value

1 (See figure 6.5 in page 174)
An Illustrative example: The Phillips Curve

for the United Kingdom 1950-1966
Prof.VuThieu
118
May 2004
6-7. Summary of Functional Forms

Table 6.5 (page 178)
Model
Equation
Slope =
dY/dX
Elasticity =
(dY/dX).(X/Y)
Linear
Y = X
(X/Y) */
Log-linear
(log-log)
lnY = lnX (YX)
Log-lin
lnY = X
X */
Lin-log
Y = lnX
2(1/X)
Y) */
Reciprocal
Y = X) - 2(1/X2)
Prof.VuThieu
- XY) */
119
May 2004
6-7. Summary of Functional Forms

Note: */ indicates that the elasticity
coefficient is variable, depending on the
value taken by X or Y or both. when no X
and Y values are specified, in practice, very
often these elasticities are measured at the
mean values E(X) and E(Y).
----------------------------------------------6-8. A note on the stochastic error term
6-9. Summary and conclusions
(pages 179-180)
Prof.VuThieu
120
May 2004
Basic Econometrics
Chapter 7
MULTIPLE REGRESSION
ANALYSIS:
The Problem of Estimation
Prof.VuThieu
121
May 2004
7-1. The three-Variable Model:

Notation and Assumptions
Yi = 1+ 2X2i + 3X3i + u i
(7.1.1)
2 , 3 are partial regression coefficients
With the following assumptions:
+ Zero mean value of U i:: E(u i|X2i,X3i) = 0. i
(7.1.2)
+ No serial correlation: Cov(ui,uj) = 0, i # j
(7.1.3)
+ Homoscedasticity: Var(u i) = 2
(7.1.4)
+ Cov(ui,X2i) = Cov(ui,X3i) = 0
(7.1.5)
+ No specification bias or model correct specified (7.1.6)
+ No exact collinearity between X variables
(7.1.7)
(no multicollinearity in the cases of more explanatory
vars. If there is linear relationship exits, X vars. Are said
to be linearly dependent)
+ Model is linear in parameters
Prof.VuThieu
122
May 2004
7-2. Interpretation of Multiple

Regression
E(Yi| X2i ,X3i) = 1+ 2X2i + 3X3i (7.2.1)
(7.2.1) gives conditional mean or

expected value of Y conditional upon
the given or fixed value of the X2 and
X3
Prof.VuThieu
123
May 2004
7-3. The meaning of partial

regression coefficients
Prof.VuThieu
Yi= 1+ 2X2i + 3X3 +.+ sXs+ ui

k measures the change in the mean
value of Y per unit change in Xk,
holding the rest explanatory variables
constant. It gives the direct effect of
unit change in Xk on the E(Yi), net of Xj
(j # k)
How to control the true effect of a
unit change in Xk on Y? (read pages
195-197)
124
May 2004
7-4. OLS and ML estimation of the

partial regression coefficients
1.
2.
3.
4.
Prof.VuThieu
This section (pages 197-201) provides:

The OLS estimators in the case of threevariable regression
Yi= 1+ 2X2i + 3X3+ ui
Variances and standard errors of OLS
estimators
8 properties of OLS estimators (pp 199-201)
Understanding on ML estimators
125
May 2004
7-5. The multiple coefficient of

determination R2 and the multiple
coefficient
ofprovides:
correlation R
This section
Prof.VuThieu
1. Definition of R2 in the context of multiple

regression like r2 in the case of two-variable
regression
2. R = R2 is the coefficient of multiple
regression, it measures the degree of
association between Y and all the explanatory
variables jointly
3. Variance of a partial regression coefficient
Var(^k) = 2/ x2k (1/(1-R2k)) (7.5.6)
Where ^k is the partial regression coefficient
of regressor Xk and R2k is the R2 in the
regression of Xk on the rest regressors
126
May 2004
7-6. Example 7.1: The

expectations-augmented Philips
Curve for the US (1970-1982)
Prof.VuThieu
This section provides an

illustration for the ideas
introduced in the chapter
Regression Model (7.6.1)
Data set is in Table 7.1
127
May 2004
7-7. Simple regression in the

context of multiple regression:
Introduction to specification bias
Prof.VuThieu
This section provides an

understanding on Simple
regression in the context of
multiple regression. It will cause
the specification bias which will be
discussed in Chapter 13
128
May 2004
7-8. R2 and the Adjusted-R2
R2 is a non-decreasing function of the number of

explanatory variables. An additional X variable will not
decrease R2
R2= ESS/TSS = 1- RSS/TSS = 1-u^2I / y^2i (7.8.1)
This will make the wrong direction by adding more
irrelevant variables into the regression and give an idea
for an adjusted-R2 (R bar) by taking account of degree of
freedom
R2bar= 1- [ u^2I /(n-k)] / [y^2i /(n-1) ] , or
(7.8.2)
R2bar= 1- ^2 / S2Y (S2Y is sample variance of Y)
K= number of parameters including intercept term
Prof.VuThieu
By substituting (7.8.1) into (7.8.2) we get

R2bar = 1- (1-R2) (n-1)/(n- k)
(7.8.4)
For k > 1, R2bar < R2 thus when number of X variables
increases R2bar increases less than R2 and R2bar can be
negative
129
May 2004
R2 is a non-decreasing function of the number of

explanatory variables. An additional X variable will not
decrease R2
R2= ESS/TSS = 1- RSS/TSS = 1-u^2I / y^2i (7.8.1)
This will make the wrong direction by adding more
irrelevant variables into the regression and give an idea
for an adjusted-R2 (R bar) by taking account of degree of
freedom
R2bar= 1- [ u^2I /(n-k)] / [y^2i /(n-1) ] , or
(7.8.2)
R2bar= 1- ^2 / S2Y (S2Y is sample variance of Y)
K= number of parameters including intercept term
Prof.VuThieu
By substituting (7.8.1) into (7.8.2) we get

R2bar = 1- (1-R2) (n-1)/(n- k)
(7.8.4)
For k > 1, R2bar < R2 thus when number of X variables
increases R2bar increases less than R2 and R2bar can be
negative
130
May 2004
Prof.VuThieu
Comparing Two R2 Values:

To compare, the size n and the dependent variable must
be the same
Example 7-2: Coffee Demand Function Revisited (page
210)
The game of maximizing adjusted-R2:
Choosing the model that gives the highest R 2bar may be

dangerous, for in regression our objective is not for that
but for obtaining the dependable estimates of the true
population regression coefficients and draw statistical
inferences about them
Should be more concerned about the logical or
theoretical relevance of the explanatory variables to the
dependent variable and their statistical significance
131
May 2004
7-9. Partial Correlation

Coefficients
This section provides:
1. Explanation of simple and partial

correlation coefficients
2. Interpretation of simple and partial
correlation coefficients
(pages 211-214)
Prof.VuThieu
132
May 2004
7-10. Example 7.3: The CobbDouglas Production function

More on functional form
Yi = 1X22i X33ieUi
(7.10.1)
By log-transform of this model:
lnYi = ln 1 + 2ln X2i + 3ln X3i + Ui

= 0 + 2ln X2i + 3ln X3i
+ Ui
(7.10.2)

Report of results is in page 216
Prof.VuThieu
133
May 2004
7-11 Polynomial Regression

Models
Yi = 0 + 1 Xi + 2 X2i ++ k Xki + Ui
(7.11.3)
Example 7.4: Estimating the Total Cost

Function
Empirical results is in page 221
-------------------------------------------------------------
Prof.VuThieu

(page 221)
134
May 2004
Basic Econometrics
Chapter 8
MULTIPLE REGRESSION
ANALYSIS:
The Problem of Inference
Prof.VuThieu
135
May 2004
Chapter 8
MULTIPLE REGRESSION ANALYSIS:
8-3. Hypothesis testing in multiple regression:
Testing hypotheses about an individual partial regression
coefficient
Testing the overall significance of the estimated multiple
regression model, that is, finding out if all the partial slope
coefficients are simultaneously equal to zero
Testing that two or more coefficients are equal to one
another
Testing that the partial regression coefficients satisfy
certain restrictions
Testing the stability of the estimated regression model
over time or in different cross-sectional units
Testing the functional form of regression models
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Chapter 8
8-4. Hypothesis testing about individual partial
regression coefficients
With the assumption that u i ~ N(0, 2) we can
use t-test to test a hypothesis about any
individual partial regression coefficient.
H0: 2 = 0
H1: 2 0
If the computed t value > critical t value at the
chosen level of significance, we may reject the
null hypothesis; otherwise, we may not reject it
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May 2004
Chapter 8
8-5. Testing the overall significance of a multiple
regression: The F-Test
For Yi = 1 + 2X2i + 3X3i + ........+ kXki + ui

To test the hypothesis H0: 2 = 3 =....= k= 0 (all
slope coefficients are simultaneously zero) versus H1: Not at
all slope coefficients are simultaneously zero,
compute
F=(ESS/df)/(RSS/df)=(ESS/(k-1))/(RSS/(n-k)) (8.5.7)
(k = total number of parameters to be estimated
including intercept)
If F > F critical = F (k-1,n-k), reject H0
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Prof.VuThieu
May 2004
Otherwise
you do not reject it
Chapter 8
regression
Alternatively, if the p-value of F obtained from
(8.5.7) is sufficiently low, one can reject H0
An important relationship between R2 and F:
F=(ESS/(k-1))/(RSS/(n-k)) or
R2/(k-1)
F = ---------------(1-R2) / (n-k)
( see prove on page 249)
Prof.VuThieu
(8.5.1)
139
May 2004
Chapter 8
regression in terms of R2
For Yi = 1 + 2X2i + 3X3i + ........+ kXki + ui
To test the hypothesis H0: 2 = 3 = .....= k = 0
(all slope coefficients are simultaneously zero)
versus H1: Not at all slope coefficients are
simultaneously zero, compute
F = [R2/(k-1)] / [(1-R2) / (n-k)] (8.5.13) (k = total
number of parameters to be estimated including
intercept)
140
If F > F critical = F (k-1,n-k), reject H0
Prof.VuThieu
May 2004
Chapter 8
regression
Alternatively, if the p-value of F obtained from
(8.5.13) is sufficiently low, one can reject H0
The Incremental or Marginal
contribution of an explanatory
variable:
Let X is the new (additional) term
in the right hand of a regression.
Under the usual assumption of the
normality of ui and the HO: = 0, it 141
Prof.VuThieu
can
be shown that the following F May 2004
Chapter 8
regression
[R2new - R2old] / Df1
F com = ---------------------(8.5.18)
[1 - R2new] / Df2
Where Df1 = number of new regressors
Df2 = n number of parameters in the
new model
R2new is standing for coefficient of determination of the
new regression (by adding X);

R2old is standing for coefficient of determination of the old
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May 2004
Chapter 8
regression
Decision Rule:
If F com > F Df1 , Df2 one can reject the Ho that = 0
and conclude that the addition of X to the model
significantly increases ESS and hence the R2 value
When to Add a New Variable? If |t| of coefficient
of X > 1 (or F= t 2 of that variable exceeds 1)
When to Add a Group of Variables? If adding a
group of variables to the model will give F value
greater than 1;
Prof.VuThieu
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May 2004
Chapter 8
8-6. Testing the equality of two regression coefficients
Yi = 1 + 2X2i + 3X3i + 4X4i + ui
(8.6.1)
Test the hypotheses:
H0: 3 = 4 or 3 - 4 = 0
(8.6.2)
H1: 3 4 or 3 - 4 0
Under the classical assumption it can be
shown:
t = [(^3 - ^4) ( 3 - 4)] / se(^3 - ^4)
follows the t distribution with (n-4) df
because (8.6.1) is a four-variable model or,
more generally, with (n-k) df. where k is the
144
total
number
of
parameters
estimated,
Prof.VuThieu
May 2004
Chapter 8
t = (^3 - ^4) / [var((^3) + var( ^4) 2cov(^3, ^4)]
(8.6.5)
Steps for testing:
1. Estimate ^3 and ^4
2. Compute se(^3 - ^4) through (8.6.4)
3. Obtain t- ratio from (8.6.5) with H0: 3 = 4
4. If t-computed > t-critical at designated level of
significance for given df, then reject H0. Otherwise do
not reject it. Alternatively, if the p-value of t statistic
from (8.6.5) is reasonable low, one can reject H0.
Example 8.2: The cubic cost function revisited
Prof.VuThieu
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May 2004
Chapter 8
8-7. Restricted least square: Testing
linear equality restrictions
Yi = 1X 22i X 33i eui (7.10.1) and (8.7.1)
Y = output
X2 = labor input
X3 = capital input
In the log-form:
lnYi = 0 + 2lnX2i + 3lnX3i + ui
(8.7.2)
with the constant return to scale: 2 + 3 = 1
(8.7.3)
Prof.VuThieu
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May 2004
Chapter 8
8-7. Restricted least square: Testing
linear equality restrictions
How to test (8.7.3)
The t Test approach (unrestricted): test of the
hypothesis H0: 2 + 3 = 1 can be conducted by t- test:
t = [(^2 + ^3) ( 2 + 3)] / se(^2 - ^3) (8.7.4)
The F Test approach (restricted least square -RLS):
Using, say, 2 = 1- 3 and substitute it into (8.7.2) we get:

ln(Yi /X2i) = 0 + 3 ln(X3i /X2i) + ui (8.7.8). Where (Yi /X2i)
is output/labor ratio, and (X3i / X2i) is capital/labor ratio
Prof.VuThieu
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May 2004
Chapter 8
8-7. Restricted least square: Testing linear equality
restrictions
u^2UR=RSSUR of unrestricted regression (8.7.2)
and u^2R = RSSR of restricted regression (8.7.7),
m = number of linear restrictions,
k = number of parameters in the unrestricted regression,
n = number of observations.
R2UR and R2R are R2 values obtained from unrestricted and
restricted regressions respectively. Then
F=[(RSSR RSSUR)/m]/[RSSUR/(n-k)] =
= [(R2UR R2R) / m] / [1 R2UR / (n-k)]
(8.7.10)
follows F distribution with m, (n-k) df.
148
Prof.VuThieu
Decision
rule: If F > F m, n-k , reject H0: 2 + 3 = 1
May 2004
Chapter 8
8-7. Restricted least square: Testing linear equality
restrictions
Note: R2UR R2R

(8.7.11)
and
u^2UR u^2R
(8.7.12)
Example 8.3: The Cobb-Douglas Production
function for Taiwanese Agricultural Sector,
1958-1972. (pages 259-260). Data in Table 7.3
(page 216)
General F Testing (page 260)
Example 8.4: The demand for chicken in the US,
1960-1982. Data in exercise 7.23 (page 228)
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May 2004
Chapter 8
8-8. Comparing two regressions: Testing for structural
stability of regression models
Table 8.8: Personal savings and income data, UK, 19461963 (millions of pounds)
Savings function:
Reconstruction period:
Y t = 1+ 2X t + U1t (t = 1,2,...,n1)
Post-Reconstruction period:
Y t = 1 + 2X t + U2t (t = 1,2,...,n2)
Where Y is personal savings, X is personal income, the
us are disturbance terms in the two equations and n1, n2
150
are the number of observations in the two period
Prof.VuThieu
May 2004
Chapter 8
+ The structural change may mean that the two
intercept are different, or the two slopes are different,
or both are different, or any other suitable combination
of the parameters. If there is no structural change we
can combine all the n1, n2 and just estimate one savings
function as:
Y t = 1 + 2X t + Ut (t = 1,2,...,n1, 1,....n2). (8.8.3)
How do we find out whether there is a structural
change in the savings-income relationship between the
two period? A popular test is Chow-Test, it is simply
the F Test discussed earlier
HO: i = i i Vs H1: i that i i
Prof.VuThieu
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May 2004
Chapter 8
+ The assumptions underlying the Chow
test
u1t and u2t ~ N(0,s2), two error terms are
normally distributed with the same
variance
u1t and u2t are independently distributed
Step 1: Estimate (8.8.3), get RSS, say, S1
with df = (n1+n2 k); k is number of
parameters estimated )
Step 2: Estimate (8.8.1) and (8.8.2)
152
Prof.VuThieu
May 2004
individually and get their RSS, say, S2 and
Chapter 8
Step 4: Given the assumptions of the
Chow Test, it can be show that
F = [S5 / k] / [S4 / (n1+n2 2k)]
(8.8.4)
follows the F distribution with Df = (k,
n1+n2 2k)
Decision Rule: If F computed by (8.8.4) >
F- critical at the chosen level of
significance a => reject the hypothesis
that the regression (8.8.1) and (8.8.2)
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Prof.VuThieu
May 2004
are the same, or reject the hypothesis of
Chapter 8
8-9. Testing the functional form
of regression:
Choosing between linear and log-linear
regression models: MWD Test
(MacKinnon, White and Davidson)
H0: Linear Model Y is a linear function of
regressors, the Xs;
H1: Log-linear Model Y is a linear function
of logs of regressors, the lnXs;
154
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May 2004
Chapter 8
8-9. Testing the functional form of regression:
Step 1: Estimate the linear model and
obtain the estimated Y values. Call them
Yf (i.e.,Y^). Take lnYf.
Step 2: Estimate the log-linear model and
obtain the estimated lnY values, call
them lnf (i.e., ln^Y )
Step 3: Obtain Z1 = (lnYf lnf)
Step 4: Regress Y on Xs and Z1. Reject H0
if the coefficient of Z1 is statistically
155
significant,
by
the
usual
t
test
Prof.VuThieu
May 2004
Chapter 8
Example 8.5: The demand for Roses
(page 266-267). Data in exercise 7.20
(page 225)
8-10. Prediction with multiple regression
Follow the section 5-10 and the
illustration in pages 267-268 by using
data set in the Table 8.1 (page 241)
8-11. The troika of hypothesis tests: The
likelihood ratio (LR), Wald (W) and
Lagarange Multiplier (LM) Tests
Prof.VuThieu
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May 2004

06econometrics Statistics Basic 1-8

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Basic Econometrics

Definition 1: Economic Measurement

Definition 2: Application of the

mathematical statistics to economic data

Definition 3: The quantitative

analysis of actual economic phenomena

(P.A.Samuelson, T.C.Koopmans and

Definition 4: The social science

which applies economics, mathematics

determination of economic laws (By H.

And the others

express economic theory in

Economic Statistics is mainly

concerned with collecting, processing

Mathematical statistics provides

many of tools for economic studies, but

mathematical model of the

1 and 2 are parameters; 1 is

econometric model of the

1 and 2 are parameters; 1is

Y^ = - 231.8 + 0.7194 X (1.3.3)

Are the estimates accord with the

With given future value(s) of X, what

1-1. Historical origin of the term

term REGRESSION was

1-1. Historical origin of the term

Law was confirmed by Karl

1-2. Modern Interpretation of

The modern way in interpretation of

Dependent Variable Y; Explanatory Variable Xs

1-3. Statistical vs.

1-4. Regression vs. Causation:

1-5. Regression vs.

the primary objective

1-6. Terminology and Notation

1-7. The Nature and Sources

1-8. Summary and Conclusions

1-8. Summary and Conclusions

2-1. A Hypothetical Example

2-1. A Hypothetical Example

2-1 gives the conditional distribution

Table 2-2: Weekly family income X ($),

and consumption Y ($)

80 100 120 140 160 180 200 220 240 260

101 113 125 137 149

2-1. A Hypothetical Example

2-1 shows the population

2-2. The concepts of population

X=Xi ) = f(Xi) is Population

2-2. The concepts of population

2-4. Stochastic Specification of PRF

= Y - E(Y X=Xi ) or Yi = E(Y X=Xi ) + Ui

2-5. The Significance of the Stochastic

2-5. The Significance of the Stochastic

2-6. The Sample Regression

Table 2-5: Another random

Weekly Income (X)

2-6. The Sample Regression

SRF1 and SRF 2

2-6. The Sample Regression

Primary objective in regression analysis is

2-6. The Sample Regression

Regression Function PRF