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# DO NOT TURN OVER UNTIL TOLD TO BEGIN

Time Allowed: 3 hours

## ANSWER BOTH QUESTIONS IN SECTION A

ANSWER ANY 2 FROM 4 QUESTIONS IN SECTION B
EACH QUESTION CARRIES EQUAL MARKS
STATISTICAL TABLES ARE PROVIDED

## SECTION A (ANSWER BOTH QUESTIONS)

1. Given the general linear model
y = X + u
Use matrix algebra to derive an expression for the OLS estimate of the
coefficient vector
(7 marks)

## 1st order condition for minimisation

Using rules of matrix differential calculus

so
= (XX)-1Xy
b) Suppose k=2, so y = X11 + X22 +u
and suppose also that
and
Find the OLS estimates of 1 and 2

(5 marks)

so

c)

## Derive an expression for the variance of the OLS estimate

(7 marks)

which if E(uu) = uI

d) How would linear dependence between the X variables affect your answers
to parts a) and c) ?
(6 marks)
Linear dependence (multicolinearity) makes the determinant of theXX matrix zero (if
exact linear dependence/colinearity) or close to zero when the variables are highly
correlated. In which case both the OLS estimate and its estimated variance (standard
errors) will be large, other things equal, and very sensitive.

## SECTION B (ANSWER ANY 2 QUESTIONS FROM 4)

1.
a) Say what you understand by the terms
i) consistency

ii) Bias

## iii) asymptotic efficiency

(8 marks)

Bias: An unbiased estimator is one where the expected (mean) value of an estimator
is equal to true value

## (centred on the true value for any sample size)

A consistent estimator converges toward the true value as the sample size becomes
infinitely large

as N

## (so may be biased in small samples)

An asymptotically efficient estimator is one which converges to the true value most
quickly , so for any N it has the smallest variance
Diagrams will help here
b) Show that the instrumental variable (IV) estimator
is a
consistent estimator of in the model y=X +u in the presence of endogeneity
(8 marks)

Hence

since

where xi is the ith row of the X matrix and zi is the ith column of the IV matrix
this term (effectively a sample average) is finite ie will not converge to zero as
sample size increases by assumption
However

Hence

## and IV is a consistent estimator

c)
Assuming that in the general linear model y=XB = u that
plim(Xu/N) = 0

and

## show, using matrix algebra, that

residuals,
residual variance 2u

plim(uu/N) = 2u
, where

## is a consistent estimator of the unobserved

(9 marks)

so

where M=I-X(XX)-1X
and MX=0

## is an idempotent matrix such that MM=M

so
and hence

As N

N/(N-k)

And the assumptions of the general linear model are that plim(Xu/N)=0, sp 2nd term
in square brackets is zero
Assuming further that plim(uU/N) = 2u
Then plim(s2)= 2u
2.
a) Give 4 properties of any maximum likelihood estimator
(8 marks)
Consistency
Asymptotic Normality
Asymptotic Efficiency
Invariance if
of g()

is the MLE

## b) Given f(x,) = x-1

find expression for the maximum likelihood estimate of
(7 marks)
Likelihood function L()

Taking logs

so

## (check s.o.c. is also satisfied)

c) Given the general linear model y =XB+u

u~N(0, 2I)

## and the multivariate normal density for u is

show that the maximum likelihood estimator of B is also the OLS estimator in
this case
(10 marks)
So Likelihood function L() = f(y1, y2,yn; )
Need f(y) rather than f(u) but we know

So L()=

so
= (XX)-1Xy =