Fall 2010 ECON422 Answers - Final Exam

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University of Maryland Prof. Razvan Vlaicu
Department of Economics

Student Name: ____________________________ December 15, 2010

Answers - Final Exam

Instructions: The total number of points is 100. Please write legibly and present your
reasoning clearly and concisely for each question.


Question 1 (10 pts.) PROBABILITY AND STATISTICS



(i) This is just a special case of what we covered in the text, with n = 4: E(Y ) =
and Var(Y ) =
2
/4.

(ii) E(W) = E(Y
1
)/8 + E(Y
2
)/8 + E(Y
3
)/4 + E(Y
4
)/2 = [(1/8) + (1/8) + (1/4) +
(1/2)] = (1 + 1 + 2 + 4)/8 = , which shows that W is unbiased. Because the Y
i
are
independent,

Var(W) = Var(Y
1
)/64 + Var(Y
2
)/64 + Var(Y
3
)/16 + Var(Y
4
)/4
=
2
[(1/64) + (1/64) + (4/64) + (16/64)] =
2
(22/64) =
2
(11/32).

(iii) Because 11/32 > 8/32 = 1/4, Var(W) > Var(Y ) for any
2
> 0, so Y is
preferred to W because each is unbiased.



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Question 2 (10 pts.) IDENTIFICATION



(i) We would want to randomly assign the number of hours in the preparation course
so that hours is independent of other factors that affect performance on the SAT. Then,
we would collect information on SAT score for each student in the experiment, yielding a
data set {( , ): 1,..., }
i i
sat hours i n = , where n is the number of students we can afford to
have in the study. From equation (2.7), we should try to get as much variation in
i
hours
as is feasible.

(ii) Here are three factors: innate ability, family income, and general health on the
day of the exam. If we think students with higher native intelligence think they do not
need to prepare for the SAT, then ability and hours will be negatively correlated. Family
income would probably be positively correlated with hours, because higher income
families can more easily afford preparation courses. Ruling out chronic health problems,
health on the day of the exam should be roughly uncorrelated with hours spent in a
preparation course.

(iii) If preparation courses are effective,
1
should be positive: other factors equal, an
increase in hours should increase sat.

(iv) The intercept,
0
, has a useful interpretation in this example: because E(u) = 0,
0
is the average SAT score for students in the population with hours = 0.

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Question 3 (15 pts.) ESTIMATION


(i)
1
< 0 because more pollution can be expected to lower housing values; note
that
1
is the elasticity of price with respect to nox.
2
is probably positive because
rooms roughly measures the size of a house. (However, it does not allow us to
distinguish homes where each room is large from homes where each room is small.)
(ii) If we assume that rooms increases with quality of the home, then log(nox) and
rooms are negatively correlated when poorer neighborhoods have more pollution,
something that is often true. We can use Table 3.2 to determine the direction of the bias.
If
2
> 0 and Corr(x
1
,x
2
) < 0, the simple regression estimator
1

has a downward bias.

But because
1
< 0, this means that the simple regression, on average, overstates the
importance of pollution. [E(
1

) is more negative than

1
.]
(iii) This is what we expect from the typical sample based on our analysis in part
(ii). The simple regression estimate, 1.043, is more negative (larger in magnitude) than
the multiple regression estimate, .718. As those estimates are only for one sample, we
can never know which is closer to
1
. But if this is a typical sample,
1
is closer to
.718.

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Question 4 (15 pts.) INFERENCE



Note: Please use a critical t-value of 2, and a critical F-value of 3.

(i) With df = n 2 = 86, we obtain the 5% critical value from Table G.2 with df =
90. Because each test is two-tailed, the critical value is 1.987. The t statistic for
H
0
:
0
= 0 is about -.89, which is much less than 1.987 in absolute value. Therefore, we
fail to reject
0
= 0. The t statistic for H
0
:
1
= 1 is (.976 1)/.049 -.49, which is
even less significant. (Remember, we reject H
0
in favor of H
1
in this case only if |t| >
1.987.)
(ii) We use the SSR form of the F statistic. We are testing q = 2 restrictions and the
df in the unrestricted model is 86. We are given SSR
r
= 209,448.99 and SSR
ur
=
165,644.51. Therefore,
(209,448.99 165,644.51) 86
11.37,
165,644.51 2
F

=



which is a strong rejection of H
0
: from Table G.3c, the 1% critical value with 2 and 90
df is 4.85.
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(iii) We use the R-squared form of the F statistic. We are testing q = 3
restrictions and there are 88 5 = 83 df in the unrestricted model. The F statistic is
[(.829 .820)/(1 .829)](83/3) 1.46. The 10% critical value (again using 90
denominator df in Table G.3a) is 2.15, so we fail to reject H
0
at even the 10% level. In
fact, the p-value is about .23.
(iv) If heteroskedasticity were present, Assumption MLR.5 would be violated, and
the F statistic would not have an F distribution under the null hypothesis. Therefore,
comparing the F statistic against the usual critical values, or obtaining the p-value from
the F distribution, would not be especially meaningful.

Question 5 (15 pts.) FUNCTIONAL FORMS, UNITS OF MEASUREMENT


(i) The turnaround point is given by
1

/(2|
2

|), or .0003/(.000000014)
21,428.57; remember, this is sales in millions of dollars.
(ii) Probably. Its t statistic is about 1.89, which is significant against the one-
sided alternative H
0
:
1
< 0 at the 5% level (cv 1.70 with df = 29). In fact, the p-
value is about .036.
(iii) Because sales gets divided by 1,000 to obtain salesbil, the corresponding
coefficient gets multiplied by 1,000: (1,000)(.00030) = .30. The standard error gets
multiplied by the same factor. As stated in the hint, salesbil
2
= sales/1,000,000, and so
the coefficient on the quadratic gets multiplied by one million:
(1,000,000)(.0000000070) = .0070; its standard error also gets multiplied by one
million. Nothing happens to the intercept (because rdintens has not been rescaled) or to
the R
2
:

rdintens = 2.613 + .30 salesbil .0070 salesbil

2

(0.429) (.14) (.0037)
n = 32, R
2
= .1484.
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(iv) The equation in part (iii) is easier to read because it contains fewer zeros to
the right of the decimal. Of course the interpretation of the two equations is identical
once the different scales are accounted for.


Question 6 (15 pts.) DUMMY VARIABLES



(i) The t statistic on hsize
2
is over four in absolute value, so there is very strong
evidence that it belongs in the equation. We obtain this by finding the turnaround point;
this is the value of hsize that maximizes sat (other things fixed): 19.3/(2 2.19) 4.41.
Because hsize is measured in hundreds, the optimal size of graduating class is about 441.

(ii) This is given by the coefficient on female (since black = 0): nonblack females
have SAT scores about 45 points lower than nonblack males. The t statistic is about
10.51, so the difference is very statistically significant. (The very large sample size
certainly contributes to the statistical significance.)

(iii) Because female = 0, the coefficient on black implies that a black male has an
estimated SAT score almost 170 points less than a comparable nonblack male. The t
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statistic is over 13 in absolute value, so we easily reject the hypothesis that there is no
ceteris paribus difference.

(iv) We plug in black = 1, female = 1 for black females and black = 0 and
female = 1 for nonblack females. The difference is therefore 169.81 + 62.31 = 107.50.
Because the estimate depends on two coefficients, we cannot construct a t statistic from
the information given. The easiest approach is to define dummy variables for three of the
four race/gender categories and choose nonblack females as the base group. We can
then obtain

Question 7 (10 pts.) HETEROSKEDASTICITY


How would you estimate this model by WLS? (One-line answer, please.)

Parts (ii) and (iii) are consequences of HESK. The homoskedasticity assumption played
no role in Chapter 5 in showing that OLS is consistent. But we know that
heteroskedasticity causes statistical inference based on the usual t and F statistics to be
invalid, even in large samples. As heteroskedasticity is a violation of the Gauss-Markov
assumptions, OLS is no longer BLUE.

With Var(u|inc,price,educ,female) =
2
inc
2
, h(x) = inc
2
, where h(x) is the heteroskedasti-
city function defined in equation (8.21). Therefore, ( ) h x = inc, and so the transformed
equation is obtained by dividing the original equation by inc:


0 1 2 3 4
(1/ ) ( / ) ( / ) ( / ) ( / ).
beer
inc price inc educ inc female inc u inc
inc
= + + + + +

Notice that
1
, which is the slope on inc in the original model, is now a constant in the
transformed equation. This is simply a consequence of the form of the heteroskedasticity
and the functional forms of the explanatory variables in the original equation.

WLS: Estimate the transformed model by OLS.
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Question 8 (10 pts.) TIME SERIES

State whether you AGREE or DISAGREE with the following statements, and provide a
brief explanation for your statement (at most three lines).

(i) The threat of confounds is bigger with time series data than it is with cross-sectional
data.

AGREE. An explanatory variable can be its own confound, because its lags and leads
may be correlated with the dependent variable.


(ii) Like cross-sectional data, time series data has the property that the observations are
independent of each other.

DISAGREE. Time series observations are related to each other by chronology.


(iii) Two time-series variables that follow the same trend are correlated.

AGREE. When one goes up the other tends to go up as well. Thats correlation.


(iv) Seasonality is not an issue when using annual time series observations.

AGREE. Seasonal effects occur within a year, so they can be detected only in monthly or
quarterly data.


(v) OLS can be used to analyze certain types of time-series data.

AGREE. OLS is an appropriate estimation method for time-series data that satisfies strict
exogeneity and no serial correlation.