Introduction to Econometrics

Lecture 3
1.Beginning to work with proper
econometrics software packages
EViews and PcGive
2. Estimators and their properties
Properties of least squares estimators
Maximum likelihood estimation
Monte Carlo studies
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The casino at Monte Carlo

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Least squares estimation again

a natural way of fitting a line through a
scatter of points with heavier penalties for
large errors
(earliest use by Gauss in 1801?)
computationally simple
provides an exact analytical solution
desirable properties (given classical
assumptions)
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properties of least squares estimators

unbiasedness, efficiency, consistency

small sample properties and asymptotic
properties
Gauss-Markov Theorem
(Best Linear Unbiased Estimator)
Mean Square Error (MSE)

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Unbiased estimation of 1

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Gauss-Markov Theorem
Given the classical assumptions,
ordinary least squares (OLS) estimators,
in the class of unbiased linear estimators,
have the minimum variance.

They are Best Linear Unbiased Estimators (BLUE).

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Efficiency
The GaussMarkov theorem states that, provided that the regression model assumptions
are valid, the OLS estimators are BLUE: best (most efficient) linear (functions of the values
of Y) unbiased estimators of the parameters.

probability density
functions

OLS
other unbiased
estimator

1
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27

unbiasedness versus minimum variance

probability density
functions

1
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27

Mean Square Error (MSE)

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Asymptotic (large sample) properties of estimators

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Maximum Likelihood Estimation the principle

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Maximizing the likelihood function

the derivation

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Maximum likelihood and least squares

estimation
Given the classical assumptions, the solution to
the problem of maximising the likelihood function
turns out to be equivalent to that obtained
by least squares estimation.
(for more details see Dougherty pages 22-36 and 312-320
and chapter 2 of Kennedy).

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Monte Carlo studies in econometrics

Monte Carlo studies are studies of the properties of estimators or test
procedures based on computer simulation experiments conducted with
artificial data which has been generated from a known data generating
process (d.g.p.)
They are particularly helpful for examining the small sample properties of
different estimators (as opposed to the asymptotic properties which can
usually be established by a combination of statistical theory and
mathematical proof).

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A simple Monte Carlo experiment

Suppose we could assume a d.g.p. of Yi = 100 + 0.5 Xi + ui

ui ~ N(0,1)

Considering small samples of say size n=30 we could fix a set of 30 X values.
Then using the random number generator of a suitable computer package
we could generate many sets of 30 values of ui
(say the number of replications R = 1000 or even 100000).
Next we use the equation to produce a set of Y values for each set of u values.
Now we can use OLS to regress each set of the Y values on X to obtain
1000 different estimates of the slope coefficient 1.
Now we can then check various claimed properties of OLS estimation such as

expectation = 0.5
variance = (1/x2)
We could also see what happened to the properties if we were, say, to use an
alternative distribution for the u values.
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Monte Carlo studies are increasingly used because of

increased

interest in the small sample properties of

estimators and tests
increased interest in procedures and tests where the
properties cannot be established by mathematical proof
improved computer power
They can also be helpful in improving a students
understanding of sampling distributions and their
properties.

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