Solutions to Midterm Exam Advanced Econometrics 1, 23 October 2013

1.

(a) The model in matrix notation is y = X + u, with = (, )0 and

1 x1

.. = [ : x] .
X = ...
.
1 xN
The FWL theorem states that the OLS estimator of can be obtained by correcting both the
second regressor vector x and the dependent vector y for the first regressor vector , i.e.,
b = (e
e,
e0 y
e)1 x

x0 x
where
e = x (0 )1 0 x = x
x
x,

e = y
y
y,

the vectors in deviation from sample averages, so that

PN
(xi x
)(yi y)
b
= i=1
.
PN
)2
i=1 (xi x
Using the model specification yi = + xi + ui , we have y = + x + u and hence
(yi y) = (xi x
) + (ui u) ,
so
PN
b=+

since

PN

i=1 (xi

) (ui
i=1 (xi x
PN
)2
i=1 (xi x

u)

=+

N
1 X
(xi x
) ui ,
N s2x
i=1

x
) u = 0.

(b) Let i = ui (xi x

); then i = E[ i ] = 0, and 2i = V[ i ] = 2 (xi x
)2 , so
N
X

2i = 2 N s2x ,

i=1

and hence

ui (xi x
)
.
zi = p
2
N s2x

We check the Liapounov condition with = 2:


4

 u (x x
h
i
1 (2M )4

)
4 (xi x
)4
 i i

E |zi |2+2 = E  p
=

,

 2 N s2x 
4 N 2 s4x
N 2 s4x
so
0 lim

N
X
i=1

N
h
i
X
1 (2M )4
1 (2M )4
E |zi |2+2 lim
=
lim
= 0,
N
N N
N 2 s4x
s4x
i=1

because limN s4x = m2x > 0. Hence by the Liapounov CLT,

1
p

N
X

2 N s2x i=1

which implies the required result.

1

(xi x
) ui N [0, 1],

(c) Using Cramers theorem and limN s2x = mx > 0,

s


N
X

2
2
1
d
b
p
.
N ( ) =
(xi x
) ui N 0,
s2x 2 N s2x
mx
i=1

This is the limiting distribution of

b is

b ); the corresponding asymptotic distribution of

N (



2
a
b
,
N ,
N mx
h
i
P
a
2 .
b
(x

)
or equivalently,
N , 2 / N
i=1 i

2.

(a) An instrument is valid if Cov[zi , ui ] = 0 and relevant if Cov[zi , xi ] 6= 0. The first condition
implies Cov[zi , yi ] = Cov[zi , xi ], and this identifies = Cov[zi , yi ]/ Cov[zi , xi ] under
the second condition.
Because the model is just-identified (one instrument for one regressor), we cannot test the
instrument
validityP
assumption, at least not based on the IV residuals u
bi , which satisfy
Pn
n
u
b
=
0
and
z
u
b
=
0
by
construction.
If
there
were
a
vector
of instruments
i=1 i
i=1 i i
zi , we could apply the Sargan OIR test.
A test for instrument relevance is the t- or F -test for 2 = 0 in the first-stage regression
x i = 1 + 2 zi + v i ,
possibly corrected for heteroskedasticity.

3.

(a) The assumptions imply that yi |xi N [x0i , exp(z0i )], with conditional density
!
1
1 (yi x0i )2
f (yi |xi ; ) = p
exp
.
2 exp(z0i )
2 exp(z0i )
Because the data are i.i.d., the log-likelihood is given by
LN () = log

N
Y

f (yi |xi ; ) =

i=1

N
X

N
X

log f (yi |xi ; )

i=1


 1 (yi x0i )2
1
log 2 exp(z0i )
2
2 exp(z0i )

i=1

i=1

i=1

1X
1X 0
N
= log 2
zi
exp(z0i )(yi x0i )2 .
2
2
2
(b) Straightforward differentiation, using the chain rule, gives
N

s
N () =

1X
exp(z0i )2(yi x0i ) (xi )
2
i=1

N
X
i=1
N
X
i=1

exp(z0i )(yi x0i )xi

xi (yi x0i )
.
exp(z0i )

(c) We have
N

i=1

i=1

X
2 LN ()
exp(z0i ) X
0
=

x
(y

x
)
(yi x0i )xi z0i ,
i
i
i
0
0
and

2 LN () X xi x0i
.
=
exp(z0i )
0
i=1

The law of iterated expectations implies








E (yi x0i 0 )xi z0i = E E (yi x0i 0 )xi z0i |xi = E xi z0i E [ui |xi ] = 0,
which proves that 2 LN ()/ 0 evaluated at 0 has mean zero. This only requires
correct specification of the conditional mean of ui , not of its normal distribution. Using
the definition of 2i0 , the required expression for the expected value of 2 LN ()/ 0
evaluated at 0 follows immediately (with no assumption of normality needed).
b in general follows from a mean-value
(d) The limiting distribution of the QML estimator
theorem for the score vector:

2 LN () 
b 0 ),
b
0 = sN () = sN ( 0 ) +
(
0 =+
a central limit theorem for the score vector
d

N 1/2 sN ( 0 ) N [0, B0 ],
and law of large numbers for the Hessian matrix:

2

p
1 LN () 
N
A0 .
0 
=+
Together these imply

d
1
b 0 )
N (
N [0, A1
0 B0 A0 ].

The results of (c) imply that A0 is block-diagonal:



A0
0
A0 =
,
0
A
0

0
2
and the partial information matrix equality implies that A
0 = B0 = E[xi xi / i0 ]. This
leads to
 
1 

b ) N 0, A
N (
,
0

and hence an estimated asymptotic variance matrix


1
1
b = 1 A
b
b ]
V[
=
N
N

N
1 X xi x0i
N

b2i
i=1

!1
=

N
X
xi x0

i=1

b2i

!1
,

b ). None of the ingredients require normality, so this asymptotic variwhere

b2i = exp(z0i
ance matrix is robust to nonnormality.