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ADVANCED
ECONOMETRICS
1
Advanced Econometrics
ADVANCED
ECONOMETRICS
CONTENTS
Chapter: 1. Econometrics 1
1.1. Introduction
1.2. Mathematical and statistical relationship
1.3. Goals of econometrics
1.4. Types of econometrics
1.5. Methodology of econometrics
1.6. The role of the computer
1.7. Exercise
Chapter: 7. Multicollinearity 61
7.1. Collinearity
7.2. Multicollinearity
7.3. Sources of multicollinearity
7.4. Types of multicollinearity
7.5. Estimation of multicollinearity
7.6. Consequences of multicollinearity
7.7. Detection of multicollinearity
7.8. Remedial measures of multicollinearity
7.9. Exercise
Chapter: 8. Hetroscedasticity 75
8.1. Nature of heteroscedasticity
8.2. Estimation of heteroscedasticity
8.3. Consequences of heteroscedasticity
8.4. Detection of heteroscedasticity
8.5. Remedial measures of heteroscedasticity
8.6. Exercise
Chapter: 9. Autocorrelation 86
9.1. Introduction
9.2. Reasons of autocorrelation
9.3. Estimation of autocorrelation
9.4. Consequences of autocorrelation
9.5. Detection of autocorrelation
9.6. Exercise
Chapter: 1
ECONOMETRICS
1.1: INTRODUCTION
Econometrics is the field of economics that concerns itself
with the application of mathematical statistics and the tools of
statistical inference to the empirical measurement of relationships
postulated by economic theory.
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THEORETICAL ECONOMETRICS
Theoretical econometrics is concerned with the development of
appropriate methods for measuring economic relationship specified
by econometric models. Since the economic data or observations
of real life and not derived from controlled experiments, so
econometrics methods have been developed for such non
experimental data.
APPLIED ECONOMETRICS
In applied econometrics we use the tools of theoretical
econometrics to study some special field of economics and business,
such as the production function, investment function, demand and
supply function, etc.
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4. Obtaining Data
To estimate the econometric model that is to obtain the
numerical values of β and β , we need data. e.g
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Year Y X
2004 55 67
2005 58 70
2006 60 72
Ŷ═ 54+0.5576X
6. Hypothesis Testing
Assuming that the fitted model is a reasonably good
approximation of reality, we have to develop suitable criteria to
find out whether the estimates obtained in accord with the
expectations of the theory that is being tested.
7. Forecasting or Prediction
If the chosen model does not refute the hypothesis or theory
under consideration, we may use it to predict the future value of
the dependent, or forecast variable Y on the basis of known or
expected future value of the explanatory or predictor variable X.
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1.7: Exercise
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Chapter: 2
Explained Explanatory
Predictand Predictor
Regressand Regressor
Response Stimulus
Endogenous Exogenous
Controlled Control
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2.2: DATA
Collection of information or facts and figures is called data.
Y═ α +βX+ e
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∑ ═ ∑(Y
═ 2∑( ( 1)
0═ 2∑(Y a bX)
0═ ∑(Y a bX)
0═ ∑Y + +b
═ 2∑(Y a bX ( X)
0═ 2∑X(Y a bX)
0═ ∑XY + + b∑
═ +
Ӯ═a+b̅
a═ ̅ b̅
═ (̅ ̅ )∑X+b
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=( ) +b
= +b
b{
b=
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[ ⁄ ]= E[ ⁄ ] = E[ ⁄ ]=
( )=E E
( )=0
8. Variability in X Values
The X values in a given sample must not all be the same.
Technically variance of X must be a finite positive number.
M.S.E [ ]
M.S.E [ ]
M.S.E [ ] [ ]
M.S.E =
Where, Bias =
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PROOF:
Y=
FOR
LINEARITY:
̅
= ̅
=
=
Where = are nonstochastic weight,
= …………
This is linear function of sample observations
UNBIASEDNESS:
=
=
= …eq. (1)
Properties of is
1.
2. =
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3.
Put these results in eq. (1).
= + …eq. (2)
E =E +
E =
Variance of :
By definition
) = E[ ]
) = E[ ]
) = E[ ]
)= ( )
, ( )
)=
)=
( )
And ̅
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FOR
LINEARITY:
=Ӯ ̅
̅
* ̅ +
+
Which is linear function of sample observations .
Where ̅
UNBIASEDNESS:
+
+ ,
Taking expectation on both sides
E( )= +
E( )=
.
Variance of :
By definition
) = E[ ]
) = E[ ]
) = E[ ] from eq. (2)
) = E[ ]
)= ( )
, ( )
)=
)= * +
)= ∑* ̅ ̅ +
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)= * ̅ ̅ +
̅
)= * +
…eq. 2
E =
E =
Variance of
= E[ ]
= E[ ]
= E[ ] …from eq. 2.
= E[ ]
=[ ]
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, ( )
= [ ]
= [ ]
= [ ]
= [ ]
is an unbiased estimator of .
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Variance of
= E[ ]
= E[ ]
= E[ ] ... From eq. 2.
= E[ ]
=[ ]
= , ( )
= [ ]
= [ ]
= [ ]
= [ ] ̅
= [ , ̅ - ]
= * , ̅ ̅ - +
* ̅ ̅ +
* ̅ +
̅
* +
Hence proved.
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2.6*** COVARIANCE OF
[ ][ ]
[ ][ ]
So ̅ ̅
=̅ ̅
̅ ̅
And ̅ ̅ ̅ ̅
̅ ̅ ̅ ̅
̅ ̅
Now we get
[ ̅ ][ ]
̅+
By subtraction
= + ̅
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= …….eq. 1.
For sample
By subtraction
̂=
[ ]
. ..eq.
Now, E[ ] * +
E[ ] [ ]
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( )
E[ ]
E[ ]
E[ ]
E[ ]
E[ ] …… eq.
E * ( ) +[ ]
E * +[ ]
E [ ]
E [ ]
E [ ]
E ……… eq.
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Put eq. .
( )=
( ) =
( ) =
( ) =
( )
E =
Let +
Mean of :
[ ] [ + ]
[ ] + )
[ ] +
Variance of :
[ ]
[ ]
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( )=∏
√
⁄
( ) ( )
…eq. (A)
= 2
0=
0=
0=
….. eq.1.
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.r.t “
= 2
0=
0=
0=
=0
.r.t “
( )
= [ ]
( )
0= [ ]
( )
0=
0=
0=
0=
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( )
( )
( )
( )
( )
𝟐
2.10: TEST OF GOODNESS OF FIT
The ratio of explained variation to the total variation is called
the coefficient of determination. The varies between 0 and 1.
̅ ( ̂) + ( ̂ ̅)
In deviation form:
Where ̅
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( ̂)
Where
E(
(̂)
(̂ )
̅ ̅
(̂ ) * + ( )
̅ ̅
(̂ )
(̂ ) [̅ ̅]
(̂ ) ̅
̅
(̂ ) * +
Prediction error ̂ is
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( ̂ ) [ ]
( ̂ ) [ ]
( ̂ ) [ ]
( ̂ )
( ̂ )
( ̂ )
( ̂ ) [( ̂ ) ( ̂ )]
( ̂ ) [ ]
( ̂ ) [ ] [ ] [ ]
( ̂ )
̅ ̅
( ̂ ) * + ( )
̅ ̅
( ̂ )
( ̂ ) [̅ ̅]
( ̂ ) ̅
̅
( ̂ ) * +
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. √ /
Z= and with (n
√ √
̅
( ( ) )
And
√ ( ) √ ( )
̅
√ ( ) , √
̅
( √ * +
̅
̂ √ * +
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X 30 60 90 120 150
Y 50 80 120 130 180
Solution:
X Y XY 𝟐 𝟐
i) Y= 𝒊
̅ ̅
̅
̅
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̂ 19.3 + 1.03X
ii) When X = 60
̂ 19.3 + 1.03(20)
̂ 19.3 + 61.8
̂ 81.1
iii) Testing for
a)
d) Computation:
̂
̂
̂
̅ ⁄
√ [ ]
√ [ ]
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e) Critical region:
| |
f) Conclusion:
Since our calculated value less than table value so
we accept , and may conclude that null hypothesis is
better than alternative hypothesis.
Testing for
a)
d) Computation:
e) Critical region:
| |
f) Conclusion:
Since our calculated value greater than table
value so we reject , and may conclude that
alternative hypothesis is better.
iv) 95% confidence interval for
̅
⁄ √ ( )
19.3
19.3
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̂
⁄ √
0.7947
v) Covariance:
̅
̅
(̂ ) * +
(̂ ) * +
(̂ ) [ ]
(̂ )
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Individual prediction:
When
̅
(̂ ) * +
(̂ ) * +
(̂ ) [ ]
(̂ )
𝟐
vii) and r :
Total Variation = Unexplained Variation + Explained Variation
̅ ( ̂) + ( ̂ ̅)
In deviation form:
Unexplained Variation ( ̂)
̅ ⁄
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2.14: Exercise
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Chapter: 3
Y=
̅ ̅ ̅ ̅
0 1
[ { } ]
√
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[ ]
And
0 1
[ { } ]
√
[ ]
or
̂
̅
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3.3: Adjusted 𝑹𝟐
The important property of that it is non-decreasing.
That is including the explanatory variable. Value of increasing
and do not decrease to adjust this we are adjusted ̅ .
Where and .
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=
√( )√( )
Hypothesis
Explained SS = Total SS
S. O. V d. f SS MS F
Regression k Explained ⁄
Residual n Residual ⁄
Total n Total
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⁄
⁄
Total Variation = ̅
Explained Variation = ( ̂ ̅) ̂
Unexplained Variation =
Regression k ∑ ⁄ ⁄
F=
⁄
Residual n ∑ ⁄
Total n ∑
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Y 5 7 8 10
1 3 9 8
2 4 3 10
Solution:
i. Estimate 𝟐 𝟐 𝑼𝒊
Y 𝟐 𝟐 𝟐
𝟐 𝟐 𝟐 𝟐
5 1 2 5 10 2 1 4 25
7 3 4 21 28 12 9 16 49
8 9 3 72 24 27 81 9 64
10 8 10 80 100 80 64 100 100
30 21 19 178 162 121 155 129 238
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( ̂)
̅ ⁄
61
iii. Testing
a)
b)
c) Test statistic
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⁄
⁄
with d.f.
d) Computation
⁄
⁄
e) Critical region
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3.8: Exercise
1. Differentiate between simple and multiple regression.
2. Write note on and ̅ .
3. Discuss the Cobb-Douglas production function.
4. How the overall significance of regression is tested?
5. Consider the following data:
Y 40 30 20 10 60 50 70 80 90
50 40 30 80 70 20 60 50 40
20 10 30 40 80 30 50 10 60
iv. Estimate and interpret
them.
v.Find and ̅ .
vi. Test the goodness of fit.
vii. Find variance of
6. Use the following data:
Y
5.5 190 49
6.5 170 58
8.0 210 55
7.5 170 58
7.0 190 55
5.0 180 49
6.0 200 46
6.5 210 46
a. Estimate by OLS.
b. Test overall significance of regression model.
c. Find adjusted coefficient of multiple correlation.
d. Find .
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Chapter: 4
GENERAL LINEAR REGRESSION (GLR)
4.1: INTRODUCTION
. . . . .
. . . . .
. . . . .
[ ] [ ] [ ]
[ ] [ ][ ] [ ]
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Assumptions of GLR:
1. [ ]
[ ]
Taking expectation on both sides
[ ] [ ]
[ ]
2. Variance
( ) [ ]
( ) [ ]
[ ]
( )
[ ]
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( )
[ ]
( )
[ ]
( )
[ ]
( )
Prove that ̂ .
Proof:
Let the population model is
Estimated model is
̂ ̂
̂ ̂
By minimizing the sum of squares of residuals that is
[ ̂] [ ̂]
[ ̂ ][ ̂]
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̂ ̂ ̂ ̂
̂ ̂ ̂ ̂
̂ ̂̂ ̂ ̂
̂
In a GLR model
̂
̂
̂ ……………..eq. (1)
2. Unbiasedness: The OLS estimator is unbiased.
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( ̂) [ ][ ]
( ̂) [ ][ ]
( ̂) [ ]
( ̂) [ ]
( ̂) [ ]
( ̂)
Example: Given
Y 4 5 6 7 8
X 2 3 4 5 7
i) Calculate SLR estimate using GLR technique.
ii) Also find their variance and covariance.
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Solution:
Y X XY 𝟐 𝟐
4 2 8 2 16
5 3 15 9 25
6 4 24 16 36
7 5 35 25 49
8 7 56 49 64
30 21 138 103 190
i)
̂ ̂
̂
∑
[ ] * +
∑ ∑
[ ] * +
| |
| | | |
* +
Now
̂
̂ * +* +
̂
̂ [ ] * + [ ]
̂
ii) Variance-covariance
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[ ]* +
[ ]
( ̂) ̂
( ̂) * +
̂ ̂ ̂
( ̂) * + 0 1
̂ ̂ ̂
4.3: POLYNOMIAL
Any algebraic expression in which the degree
of “X” is non-negative i.e. positive or zero is known as
polynomial. E.g.
Y=
PLYNOMIAL REGRESSION
It is a simple multiple linear regression, where
explanatory variables are all powers of a single variable. E.g
second degree polynomial variable in which
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4.4: Exercise
* +
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̅ , ̅ , ̅
,
a) Find the estimates of ̂ ̂ . Also find their
variances and covariance.
b) How would you estimate ̂
c) Test the hypothesis that ̂ ̂ .
d) And ̅ .
8. Given the following data:
2 1 3
3 5 4
8 6 7
10 8 6
12 10 11
16 13 14
19 17 18
20 21 20
22 23 25
25 24 27
Find:
a) Estimate the model in deviation form .
b) ( ̂)
c) 95% confidence interval of ̂ and ̂ .
d) Test the hypothesis when ̂ .
e) And . ̅
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Chapter: 5
DUMMY VARIABLES
Econometric models are very flexible as they allow for the
use of both qualitative and quantitative explanatory variables. For
the quantitative response variable each independent variable can
either a quantitative variable or a qualitative variable, whose levels
represent qualities and can only be categorized. Examples of
qualitative variables may be male and female, black and white etc.
But for a qualitative variable, a numerical scale does not exist. We
must assign a set of levels to qualitative variable to account for the
effect that the variable may have on the response, then we use
dummy variables.
EXAMPLE:
Where
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Suppose Sex
3000 Female 0
4000 Male 1
5000 Female 0
6000 Male 1
Using OLS method. There is only one dummy variable in the model.
( ⁄ )
( ⁄ )
We consider a model
Where
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EXAMPLES:
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5.4: Exercise
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Chapter: 6
6.3: LAG
In economics the dependence of a variable Y
(dependent variable) on other variables (explanatory variable) is
rarely instantaneous (happen immediately). Very often Y responds
to X with a laps of time, such a laps of time is called a lag.
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2) Koyck Approach
. .
. .
. .
……eq. (B)
...eq. (C)
….eq. (D)
…..eq. (E)
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6.7: Exercise
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Chapter: 7
MULTICOLLINEARITY
7.1: Collinearity
In a multiple regression model with two independent
variables, if there is linear relationship between independent
variables, we say that there is collinearity.
7.2: Multicollinearity
If there are more than two independent variables and they
are linearly related, this linear relationship is called
multicollinearity.
Multicollinearity arises from the presence of
interdependence among the regressors in a multivariable equation
system. The departure of orthognality in the set of regressors in a
measure of multicollinearity. It means the existence of a perfect or
exact linear relationship among some or all explanatory variables.
When the explanatory variables are perfectly correlated, the
method of least squares breaks down.
7.3: Sources of Multicollinearity
The data collection method employed for example,
sampling over a limited range of the values taken by the
regressors in the population.
Constraints on the model or in the population being
sampled. In the regression of electricity consumption (Y)
on income ( ) and house size ( ) there is a physical
constraints in the population in that families with higher
income generally larger homes than families with lower
income.
Model specification: For example adding polynomial
terms to a regression model, especially when the range of
the variable is small.
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Perfect Multicollinearity
Imperfect Multicollinearity
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( )
̂ And
( )( )
( )
̂
( )( )
( )
̂
( )( )
( ) ( )
̂
( )( ) ( )
[ ( ) ( )]
̂
[( ) ( ) ]
[ ]
̂
[ ]
̂ .
Similarly,
( )
̂
( )( )
( ) ( )
̂
( )( ) ( )
[ ( ) ( )]
̂
[( ) ( ) ]
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[ ]
̂
[ ]
(̂ )
( )( ) ( )
(̂ )
( )( ) ( )
(̂ )
( )( ) ( )
(̂ )
[( ) ( ) ]
(̂ )
(̂ )
(̂ ) .
Similarly,
(̂ )
( )( ) ( )
(̂ )
( )( ) ( )
(̂ )
( )( ) ( )
(̂ )
[( ) ( ) ]
(̂ )
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(̂ )
(̂ ) .
̂ ̂
Put
̂ ̂
̂ ̂
Where ̂ ̂ ̂
Regression in y on x is:
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( )
̂ And
( )( )
( )
̂
( )( )
( )
̂
( )( )
( ) ( )
̂
( )( ) ( )
[ ( ) ( )]
̂
[( ) ( ) ]
[ ]
̂
[ ]
̂ .
Similarly,
( )
̂
( )( )
( ) ( )
̂
( )( ) ( )
[ ( ) ( )]
̂
[( ) ( ) ]
[ ]
̂
[ ]
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0 1
* ⁄
+
* ⁄
+
[ ]
⁄√
* +
Putting
* +
* +
Infinitely large.
Similarly:
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* +
* ⁄
+
* ⁄
+
[ ]
⁄√
* +
Putting
* +
* +
Infinitely large
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* +
[ ]
In case of
If
* +
* +
* +
5) In case of multicollinearity the confidence interval
becomes wider.
6) In the presence of multicollinearity the t-test will be
misleading.
7) In the presence of multicollinearity prediction is not
accurate.
7.7: DETECTION OF MULTICOLLINEARITY
1. The Farrar and Glauber Test of Multicollinearity
A statistical test for multicollinearity has been developed by
Farrar and Glauber. It is really a set of three tests.
a) The first test is a 𝟐 test for the detection of the
existence and the severity of multicollinearity in a function
including several explanatory variables.
Procedure:
i.
.
ii. Choose level of significance at
iii. Test statistic to be used
* +
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iv. Computations:
Compute the multiple correlation coefficients
among the explanatory variables.
v. Critical Region: F
vi. Conclusion:
Reject if our calculated value is greater than
table value. Otherwise accept.
c) The third test is a t-test for finding out the pattern
of multicillinearity that is for determining which variables are
responsible for the appearance of the multicollinear variable.
Procedure:
i.
with
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iv. Computations:
Computed the partial correlation
coefficients.
v. Critical Region: | |
vi. Conclusion:
Reject if our calculated value
is greater than table value. Otherwise
accept.
2. High Pair Wise Correlation among Regressors
regressor increases VIF all the increases and the limit it can
be infinite.
VIF
( )
Tolerance ( )
i. A Prior Information
Suppose we consider the model
Where Y = Consumption,
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Where
Once we obtain we can estimate from the
postulated relationship between and .
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7.9: Exercise
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Chapter: 8
HETEROSCEDASTICITY
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[ ]
=
=
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= +
E =E +
E =
Variance of :
By definition
) = E[ ]
) = E[ ]
) = E[ ]
) = E[ ]
)= ( )
By assumption of heteroscedasticity
, ( )
)=
)=
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2. Glejser Test
I. | |
II. | | √
III. | | ( )
IV. | | ( )
√
V. | | √
VI. | | √
Stages of Glejser test:
Stage 1: Fit a model Y on X and compute .
Stage 2: Take the absolute value of and then regress
with X using any one of functional form.
Where | |
Step 4: For n
√
with d.f.
√
Step 5: C.R | | ⁄
( ) ( )
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Step 6. Conclusion:
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𝟐
(b) When is unknown
𝒊
We consider two variable regression model.
That is
.
Proof: Dividing original model by .
( )
( )
.
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√ √ √ √
( )
√
( )
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( )
( )
[ ]
[ ]
[ ]
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8.9: Exercise
Year Y X
2002 37 4.5
2003 48 6.5
2004 45 3.5
2005 36 3.0
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Chapter: 9
AUTOCORRELATION
9.1: INTRODUCTION
Autocorrelation refer to a case in which the error term in
one time period is correlated with the error term in any other time
period. As “correlation between members of series of observations
ordered in time as in case of time series data or space as in case of
cross-sectional data”.
One of the assumptions of linear regression model is
that there is zero correlation between error terms. That is
( )
If the above assumption is not satisfied than there is
autocorrelation, that is if the value of in any particular period is
correlated with its own preceding value or values. Therefore it is
known as the autocorrelation or serial correlation. That
is ( ) . Autocorrelation is a special case of correlation.
Autocorrelation is referring to the relationship not between two
different variables but between the successive values of the same
variable.
Autocorrelation:
Lag correlation of a given series with itself is called
autocorrelation, thus correlation between two time series such as
is called autocorrelation.
Serial Correlation:
Lag correlation between two different series is called
serial correlation, thus correlation between two different series
such as
is called serial correlation.
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3) Specification Bias:
Autocorrelation also arises due to specification bias,
arises from true variables excluded from model and wrong
use of functional form.
4) Lags:
Regression models using lagged values in time
series data occur relatively often in economics, business
and some fields of engineering. If we neglect the lagged
term from the autoregressive model, the resulting error
term will reflect a systematic pattern and therefore
autocorrelation will be present.
5) Data Manipulation:
For empirical analysis, the raw data are often
manipulated. Manipulation introduces smoothness into the
raw data by dampening the fluctuations. This manipulation
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Mean:
Variance: By definition:
[ ]
[ ]
[ ]
[ ]
, r=0, 1, 2, 3...
[ ]
The expression in brackets is a sum of a geometric
progression of infinite term.
* +
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Where
Covariance:
[ ][ ]
[ ]
Given that
…
[ ]
[ ]
[ ]
[ ] [ ]
[ ]
[ [ ] [ ] ]
[ ]
[ ]
* ( )+
* +
Similarly:
In general
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( )
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Where then
* +
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9.7: Exercise
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Chapter: 10
i. Endogenous variable
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Example:
…………. (i)
…………. (ii)
……(*)
……. (iii)
[ ]
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……. (iv)
Advantages of ILS
1) The derivation of the reduced form π‟s from the structural β‟s
and the Y‟s is more efficient.
2) Structural changes occur continuously over time.
3) Extraneous information is same structural parameters may
become available from other studies.
Disadvantages of ILS
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Proof:
…….. (1)
And, [ ]
……… (2)
Then
̅
̅ ………. (3)
̅
And, ̅ ………. (4)
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Advanced Econometrics
̅ ̅ …….. (5)
̅
̅
̅ ̅ ……(6)
We know that
[ ̅ ̅ ]
*, ̅ - ̅ +
* ̅ ̅ +
̅ ̅
……….(7)
Similarly
[ ̅ ̅ ]
*{ ̅ ̅ +
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̅ ̅
…………(8)
̂
[ ]
̂
[ ]
Similarly
̅ ̅
̂
* + ̅* +
̂
[ ̅ ̅ ̅ ]
̂
[ ]
̅
̂
̅
̂
̂
̂
Hence proved ̂ and ̂ are consistent estimators of and .
Stage 1:
In the first stage each endogenous variable is regressed on
all the predetermined variable of the system. At this stage we get
the new reduced form equation.
Stage11:
In the second stage predicted values rather than the actual
values of endogenous are used to estimate the structural equation of
the model. That is, we obtain the estimates ̂ . From stage first and
replacing ̂ in the original equation by the estimated ̂ and then
apply OLS to the equation thus transformed.
The predicted values of the endogenous variable are uncorrected
with the error term which will give us two stages least square
parameters estimates.
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Question: Find out the 2SLS estimate and show that in case of exactly
identified 2SLS is same as ILS.
Proof:
… (1)
… (2)
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… (3)
[ ]
… (4)
̂ ̂ ̂
(̂ ̂) ̅ ⁄
̂ ̅ ⁄
̂ ̅ ̂ ̅
Residual
̂ ̂ … (4)
̂ ̂
̂ ̂
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̂ ̂ ̂
̂ ̂
̂̂
̂ * ̅ ̂ ̂ +
̂ [ ̅ ̂ ̂ ̂ ̂ ̅ ]
̂ [ ̅ ̂ ̂ ̅ ]
̂ [ ̅ ̂ ̅ ]
̂ ̂ [ ̅ ̅ ]
̂ ̂
̂̂ (̂ ̂)
̂̂ ̂ ̂ ̂ ̂ ̅
̂̂ ̂ ̂ ̅
̂̂ ̂ ̅
̂̂ ̂
̂
̂
̂
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̂
̂
̂ ̂
̂ ̂
It means that 2SLS and ILS are same in case of exactly identified.
̂ ̅ ̂ ̂
̂ ̅ ̂
̂ ̅
= ̅+ ̅
̂ ̅
̂ ̅ ̅ + ̅)
̅ ̅ ̅
̂
̅ ̅
̂
̅ ̅
̂
̂ ̂ Hence proved.
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Procedure of IV Method
Step I:
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Step II:
Properties of IV
Assumption of IV method
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10.5: Exercise
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Chapter: 11
IDENTIFICATION
11.1 INTRODUCTION
By identification, we mean whether numerical estimates of
the parameters of the structural equation can be obtained from the
estimated reduced form equations.
…eq (1)
…eq (2)
Solution:
… Eq (*)
Put eq (*) in
[ ]
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2) Equation Identified
…eq (1)
…eq (2)
Solution:
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… Eq (*)
Put eq (*) in
* +
b. Over Identification
…eq (1)
…eq (2)
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Solution:
… Eq (*)
Put eq (*) in
[ ]
…eq (1)
…eq (2)
Solution:
K=1 , M=2
For eq (1).
k=1 , m=2
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…eq (1)
…eq (2)
Solution:
K=3 , M=2
For eq (1).
k=2 , m=2
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Rank Condition
d) The entries left in the table will give only the coefficient
of variables included in the system but not in the equation
under consideration.
Solution:
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Equation
1 -1 - 0 0 0
2 0 0 0 -1 0
3 0 -1 0 0 0
4 1 -1 0 1 0 1
Consider equation 1.
[ ]
| | | | | | | |
| |
Consider equation 2.
[ ]
| | | | | | | |
| |
| |
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Consider equation 3.
[ ]
| | | | | | | |
| |
| |
Consider equation 4.
[ ]
| |
| |
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a) Rank condition
b) Order condition
Solution:
a) Rank condition
Equation
1 1 0 0 0
2 0 1 0 0
3 0 1 0 0
4 0 1 0 0
Consider equation 1.
[ ]
| | | | | | | |
| |
Consider equation 2.
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[ ]
| | | | | | | |
| |
Consider equation 3.
[ ]
| | | | | | | |
| |
Consider equation 4.
[ ]
| | | | | | | |
| |
| |
| |
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b) Order condition
i.e. ( )
K=3 i.e. ( )
For equation 1:
m=3 i.e. ( )
For equation 2:
m=2 i.e. ( )
For equation 3:
m=2 i.e. ( )
For equation 4:
m=3 i.e. ( )
For equation 1:
k=1 i.e. ( )
For equation 2:
k=2 i.e. ( )
For equation 3:
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Advanced Econometrics
k=2 i.e. ( )
For equation 4:
k=1 i.e. ( )
Equation Result
1 Identified
2 Identified
3 Identified
4 Identified
Thus by order condition all the equations are identified but by
rank condition only equation 4 is identified.
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11.4: Exercise
… (1)
… (2)
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