mV eouus tebe
JACK JOHNSTON
JOHN DiNARDOhttp://www.mhcollege.com
P/N 032720-3
PART OF
ISBN O-07-913121-2
A
McGraw-Hill
A Division of The McGraw-Hill Companiesvi
ECONOMETRIC METHODS
1.3. To derive cov(a, b)
1.4 Gauss-Markov theorem
1.5. To derive var(eo)
Problems
Further Aspects of Two-Variable Relationships
2.1 Time as a Regressor
21.1 Constant Growth Curves ~
2.1.2 Numerical Example
2.2. Transformations of Variables
2.2.1 Log-Log Transformations
2.2.2. Semilog Transformations
2.2.3 Reciprocal Transformations
23. An Empirical Example of a Nonlinear Relation: U.S. Inflation
and Unemployment
24° Lagged Dependent Variable as Regressor
24.1 An Introduction to Asymptotics
24.2 Convergence in Probability
24,3 Convergence in Distribution
24.4 The Autoregressive Equation
2.5. Stationary and Nonstationary Series
2.5.1 Unit Root
2.5.2 Numerical IMustration
2.6 Maximum Likelihood Estimation of the Autoregressive Equation
2.6.1 Maximum Likelihood Estimators
2.6.2. Properties of Maximum Likelihood Estimators
Appendix
2.1 Change of variables in density functions
2.2 Maximum likelihood estimators for the AR(1) model
Problems
The k-Variable Linear Equation
3.1 Matrix Formulation of the &-Variable Model
1.1 The Algebra of Least Squares
3.1.2 Decomposition of the Sum of Squares
3.1.3 Equation in Deviation Form
3.2. Partial Correlation Coefficients
3.2.1 Sequential Buildup of the Explained Sum of Squares
3.2.2 Partial Correlation Coefficients and Multiple
Regression Coefficients
3.2.3 General Treatment of Partial Correlation and Multiple
Regression Coefficients
3.3 The Geometry of Least Squares
3.4 Inference in the k-Variable Equation
3.4.1 Assumptions
3.4.2 Mean and Variance of b
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873.4.3. Estimation of o?
3.4.4 Gauss—Markov Theorem
3.45. Testing Linear Hypotheses about B
3.46 Restricted and Unrestricted Regressions
3.4.7 Fitting the Restricted Regression
3.5. Prediction
Appendix
3.1 To prove rig = (riz ~ nist VIF JT
3.2. Solving fora single regression coefficient in a multiple regression
3.3 To show that minimizing a’a subject to X’a = c gives
a= XXX) e
3.4 Derivation of the restricted estimator b.
Problems
Some Tests of the k-Variable Linear Equation
for Specification Error
4.1 Specification Error
4.1.1 Possible Problems with w
4.1.2. Possible Problems with X
4.1.3 Possible Problems with B
4.2. Model Evaluation and Diagnostic Tests
4.3. Tests of Parameter Constancy
4.3.1 The Chow Forecast Test
43.2. The Hansen Test
4.3.3. Tests Based on Recursive Estimation
43.4 One-Step Ahead Prediction Errors
43.5 CUSUM and CUSUMSQ Tests,
43.6 A More General Test of Specification Error:
‘The Ramsey RESET Test
44 A Numerical Illustration
45. Tests of Structural Change
4.5.1 Test of One Structural Change
45.2 Tests of Slope Coefficients
45.3. Tests of Intercepts
45.4 Summary
45.5 A Numerical Example
45.6 Extensions
46/ Dummy Variables ’
4.6.1 Introduction
46.2 Seasonal Dummies
4.6.3 Qualitative Variables
4.6.4 Two ot Mote Sets of Dummy Variables
4.6.5 A Numerical Example
Appendix
4.1 To show var(d) = 0? |I,, + Xo(X}Xi)'X3]
Problems
Contents
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139vi
BCONOMETRIC METHODS
\5 Maximum Likelihood (ML), Generalized Least Squares
\ (GLS), and Instrumental Variable (IV) Estimators
a
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‘Maximum Likelihood Estimators
5.1.1 Properties of Maximum Likelihood Estimators
ML Estimation of the Linear Model
Likelihood Ratio, Wald, and Lagrange Multiplier Tests
5.3.1 Likelihood Ratio (LR) Tests
5.3.2 The Wald (W) Test
5.3.3 Lagrange Multiplier (LM) Test
ML Estimation of the Linear Model with Nonspherical Disturbances
5.4.1 Generalized Least Squares
Instrumental Variable (IV) Estimators
5.5.1 Special Case
5.5.2. Two-Stage Least Squares (2SLS)
5.5.3 Choice of Instruments
5.5.4 Tests of Linear Restrictions
Appendix
Sd
5.2
53
Change of variables in density functions
Centered and uncentered R?
To show that €,X(X'X)"!X'e. = ele. — e'e
Problems
Heteroscedasticity and Autocorrelation
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Properties of OLS Estimators
Tests for Heteroscedasticity
6.2.1 The White Test
6.2.2. The Breusch-Pagan/Godfrey Test
6.2.3. The Goldfeld-Quandt Test
62.4 Extensions of the Goldfeld-Quandt Test
Estimation Under Heteroscedasticity
6.3.1 Estimation with Grouped Data
6.3.2 Estimation of the Heteroscedasticity Relation
Autocorrelated Disturbances
6.4.1 Forms of Autocorrelation: Autoregressive and Moving
Average Schemes
6.4.2 Reasons for Autocorrelated Disturbances
OLS and Autocorrelated Disturbances
‘Testing for Autocorrelated Disturbances
6.6.1 Durbin-Watson Test
6.6.2 The Wallis Test for Fourth-Order Autocorrelation
6.6.3 Durbin Tests for a Regression Containing Lagged Values
of the Dependent Variable
6.6.4 Breusch-Godfrey Test
66.5 Box-Pierce-Ljung Statistic
Estimation of Relationships with Autocorrelated Disturbances
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1886.8 Forecasting with Autocorrelated Disturbances
6.9 Autoregressive Conditional Heteroscedasticity (ARCH)
Appendix
6.1 LM test for multiplicative heteroscedasticity
6.2. LR test for groupwise homoscedasticity
6.3. Properties of the ARCH(1) process
Problems
Univariate Time Series Modeling
7.1 A Rationale for Univariate Analysis
71.1 The Lag Operator
7.1.2. ARMA Modeling
7.2 Properties of AR, MA, and ARMA Processes
7.2.1 AR(1) Process
7.2.2 AR(Q) Process
7.23 MA Processes
7.2.4 ARMA Processes
7.3 Testing for Stationarity
73.1 Graphical Inspection
7.3.2. Integrated Series
7.3.3 Trend Stationary (TS) and Difference Stationary (DS) Series
7.3.4 Unit Root Tests
73.5 Numerical Example
7.4 Identification, Estimation, and Testing of ARIMA Models
74.1 Identification
7.4.2 Estimation
7.4.3 Diagnostic Testing
7.5 Forecasting
7.5.1 MA(1) Process
7.5.2. ARMA(I,1) Process
7.5.3. ARIMA(I,1,0) Process
7.6 Seasonality
7.7 A Numerical Example: Monthly Housing Starts
Problems
Autoregressive Distributed Lag Relationships
8.1 Autoregressive Distributed Lag Relations
8.1.1 A Constant Elasticity Relation
8.1.2 Reparameterization a
8.1.3 Dynamic Equilibrium
8.1.4 Unit Elasticity
8.1.5 Generalizations
8.2 Specification and Testing
8.2.1 General to Simple and Vice Versa
8.2.2 Estimation and Testing
8.2.3 Exogeneity
Contents
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253X__ ECONOMETRIC METHODS
8.2.4 Exogeneity Tests
8.2.5 The Wu-Hausman Test
8.3 Nonstationary Regressors
84 ANumerical Example
8.4.1 Stationarity
8.4.2 Cointegration
8.4.3 A Respecified Relationship
8.4.4 A General ADL Relation
8.4.5 A Reparameterization
8.5 Nonnested Models
‘Appendix
8.1 Nonsingular linear transformations of the variables
in an equation
8.2. To establish the equality of the test statistics in Eqs. (8.37)
and (8.41)
Problems
9 Multiple Equation Models
9.1 Vector Autoregressions (VARs)
9.1.1 A Simple VAR
9.1.2. A Three-Variable VAR
9.1.3 Higher-Order Systems
9.2. Estimation of VARs
9.2.1 Testing the Order of the VAR
9.2.2 Testing for Granger Causality
. 9.2.3 Forecasting, Impulse Response Functions,
and Variance Decomposition
9.2.4 Impulse Response Functions
9.2.5 Orthogonal Innovations
9.2.6 Variance Decomposition
9.3. Vector Error Correction Models
9.3.1 Testing for Cointegration Rank
9.3.2 Estimation of Cointegrating Vectors
9.3.3 Estimation of a Vector Error Correction Model
9.4 Simultaneous Structural Equation Models
9.5 Identification Conditions
9.6 Estimation of Structural Equations
9.6.1 Nonstationary Variables
9.6.2 System Methods of Estimation
Appendix
9.1 Seemingly Unrelated Regressions (SUR)
9.2 Higher-order VARs
9.2.1 A VAR(I) Process
9.2.2. A VAR(2) Process
Problems
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322Contents xi
10 Generalized Method of Moments
v
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10.1
10.2
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10.4
10.5
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10.7
‘The Method of Moments
OLS as a Moment Problem
Instrumental Variables as a Moment Problem
GMM and the Orthogonality Condition
Distribution of the GMM estimator
Applications
10.6.1 Two-Stage Least Squares, and Tests
of Overidentifying Restrictions
10.6.2. Wu-Hausman Tests Revisited
10.6.3. Maximum Likelihood
10.6.4 Euler Equations
Readings
Problems
A Smorgasbord of Computationally Intensive Methods
Wd
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An Introduction to Monte Carlo Methods
11.1.1 Some Guidelines for Monte Carlo Experiments
11.1.2 An Example
11.1.3 Generating Pseudorandom Numbers
11.1.4 Presenting the Results
Monte Carlo Methods and Permutation Tests
The Bootstrap
11.3.1 The Standard Error of the Median
11.3.2 An Example
11.3.3. The Parametric Bootstrap
11.3.4 Residual Resampling: Time Series and Forecasting
11.3.5 Data Resampling: Cross-Section Data
11.3.6 Some Remarks on Econometric Applications of the Bootstrap
Nonparametric Density Estimation
11.4.1 Some General Remarks on Nonparametric Density Estimation
11.4.2 An Application: The Wage Effects of Unions
Nonparametric Regression
11.5.1 Extension: The Partially Linear Regression Model
References
Problems
Panel Data
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12.5
Sources and Types of Panel Data
The Simplest Case—The Pooled Estimator
‘Two Extensions to the Simple Model
The Random Effects Model
Random Effects as a Combination of Within and Between Estimators
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13
ECONOMETRIC METHODS
12.6 The Fixed Effects Model in the Two-Period Case
12.7 The Fixed Effects Model with More Than Two ‘Time Periods
12.8 The Perils of Fixed Effects Estimation
12.8.1 Example 1: Measurement Error in X
12.8.2 Example 2: Endogenous X
12.9 Fixed Effects or Random Effects?
12.10 A Wu-Hausman Test
12.11 Other Specification Tests and an Introduction to Chamberlain's
Approach
12.11. Formalizing the Restrictions
1211.2 Fixed Effects in the General Model
12.113 Testing the Restrictions
12.12, Readings
Problems
Discrete and Limited Dependent Variable Models
13.1 Types of Discrete Choice Models
13.2. The Linear Probability Model
13.3 Example: A Simple Descriptive Model of Union Participation
13.4 Formulating a Probability Model
13.5 The Probit
13.6 ‘The Logit
13.7 Misspecification in Binary Dependent Models
13.7.1 Heteroscedasticity
13.7.2 Misspecification in the Probit and Logit
13.7.3. Functional Form: What Is the Right Model to Use?
13.8 Extensions to the Basic Model: Grouped Data
13.8.1 Maximum Likelihood Methods
13.8.2 Minimum y* Methods
13.9 Ordered Probit
13.10 Tobit Models
13.10.1_ ‘The Tobit as an Extension of the Probit
13.102. Why Not Ignore “The Problem”?
13.103 Heteroscedasticity and the Tobit
13.11 Two Possible Solutions
13.11.1 Symmetrically Trimmed Least Squares
13.11.2. Censored Least Absolute Deviations (CLAD) Estimator
13.12. Treatment Effects and Two-Step Methods
1312.1 The Simple Heckman Correction
1312.2 Some Cautionary Remarks about Selectivity Bias
13.12.3 The Tobit as a Special Case
13.13 Readings
Problems
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452Appendix A
Al
Vectors
A.L1 Multiplication by a Scalar
A.1.2 Addition and Subtraction
A.13 Linear Combinations
A.L4 Some Geometry
ALS Vector Multiplication
A.L6 Equality of Vectors
A2 Matrices
A2.1 Matrix Multiplication
A.2.2 The Transpose of a Product
A23 Some Important Square Matrices
A24 Partitioned Matrices
A25 — Matrix Differentiation
A.2.6 Solution of Equations
A27 The Inverse Matrix
A28 The Rank of a Matrix
A.2.9 Some Properties of Determinants
A2.10 Properties of Inverse Matrices
A2.11 More on Rank and the Solution of Equations
A212 Eigenvalues and Bigenvectors
A.2.13 Properties of Eigenvalues and Eigenvectors
A214 Quadratic Forms and Positive Definite Matrices
Appendix B
B.1__ Random Variables and Probability Distributions
B.2__ The Univariate Normal Probability Distribution
B.3_ Bivariate Distributions
B.4__ Relations between the Normal, x, t, and F Distributions
B.5 Expectations in Bivariate Distributions
B.6 Multivariate Densities
B.7 Multivariate Normal pdf
B.8__ Distributions of Quadratic Forms
B.9 Independence of Quadratic Forms
B.10 Independence of a Quadratic Form and a Linear Function
Appendix C
Appendix D
Index
Contents
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521CHAPTER 1
Relationships between Two Variables
The economies literature contains innumerable discussions of relationships be-
tween variables in pairs: quantity and price; consumption and income; demand for
money and the interest rate; trade balance and the exchange rate; education and
income; unemployment and the inflation rate; and many more. This is not to say that
economists believe that the world can be analyzed adequately in terms of a collection
of bivariate relations. When they leave the two-dimensional diagrams of the text-
books behind and take on the analysis of real problems, multivariate relationships
abound. Nonetheless, some bivariate relationships are significant in themselves;
more importantly for our purposes, the mathematical and statistical tools developed
for two-variable relationships are fundamental building blocks for the analysis of
more complicated situations,
11
EXAMPLES OF BIVARIATE RELATIONSHIPS
Figure 1.1 displays two aspects of the relationship between real personal saving
(SAV) and real personal disposable income (INC) in the United States. In Fig. 1.la
the value of each series is shown quarterly for the period from 1959.1 to 1992.1.
These two series and many of the others in the examples throughout the book come
from the DRI Basic Economics Database (formerly Citibase); where relevant, we
indicate the correspondence between our labels and the Citibase labels for the vari-
ables. Figure I.La is a typical example of a time series plot, in which time is dis-
played on the horizontal axis and the values of the series are displayed on the vertical
axis. Income shows an upward trend throughout the period, and in the early years,
saving does likewise. This pattern, however, is not replicated in the middle and later
1A definition of all series is given in the data disk, which accompanies this volume, Instructions for
accessing the disk are given in Appendix C. :2. BCONOMETRIC METHODS
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FIGURE 1.1
Saving and income.cuarter 1: Relationships between Two Variables 3
years. One might be tempted to conclude from Fig. 1.1a that saving is much more
volatile than income, but that does not necessarily follow, since the series have sep-
arate scales.”
An alternative display of the same information is in terms of a scatter plot,
shown in Fig. 1.1b, Here one series is plotted against the other. The time dimension
is no longer shown explicitly, but most software programs allow the option of joining
successive points on the scatter so that the evolution of the series over time may still
be traced. Both parts of Fig. 1.1 indicate a positive association between the variables:
increases in one tend to be associated with increases in the other. It is clear that
although the association is approximately linear in the early part of the period, it is
not so in the second half,
Figures 1.2 and 1.3 illustrate various associations between the natural log of real
personal expenditure on gasoline (GAS), the natural log of the real price of gasoline
(PRICE), and the natural log of real disposable personal income (INCOME). The
derivations of the series are described in the data disk. The rationale for the logarith-
mic transformations is discussed in Chapter 2. Figure 1.2 gives various time plots of
gasoline expenditure, price, and income. The real price series, with 1987 as the base
year, shows the two dramatic price hikes of the early and late 1970s, which were
subsequently eroded by reductions in the nominal price of oil and by U.S. inflation,
so the real price at the end of the period was less than that obtaining at the start,
The income and expenditure series are both shown in per capita form, because U.S.
population increased by about 44 percent over the period, from 176 million to 254
million, The population series used to deflate the expenditure and income series is
the civilian noninstitutional population aged 16 and over, which has increased even
faster than the general population. Per capita real expenditure on gasoline increased
steadily in the 1960s and early 1970s, as real income grew and real price declined.
This steady rise ended.with the price shocks of the 1970s, and per capita gas con-
sumption has never regained the peak levels of the early seventies.
The scatter plots in Fig. 1.3 further illustrate the upheaval in this market. The
plot for the whole period in Fig. 1.3a shows very different associations between ex-
penditure and price in the earlier and later periods. The scatter for 1959.1 to 1973.3 in
Fig. 1.3b looks like a conventional negative association between price and quantity.
This is shattered in the middle period (1973.4 to 1981.4) and reestablished, though
with a very different slope, in the last period (1982.1 to 1992.1). This data set will
be analyzed econometrically in this and later chapters.
These illustrative scatter diagrams have three main characteristics. One is the
sign of the association or covariation—that is, do the variables move together in
a positive or negative fashion? Another is the strength of the association. A third
characteristic is the linearity (or otherwise) of the association—is the general shape
of the scatter linear or curvilinear? In Section 1.2 we discuss the extent to which the
correlation coefficient measures the first two characteristics for a linear association,
and in later chapters we will show how to deal with the linearity question, but first
we give an example of a bivariate frequency distribution.
2See Problem 1.1