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# 2016/4/11

## 2.4 Units of measurement & fn. form

Effects of changing units of measurement
Example 2.3, CEO salary and Return on Equity

Econometrics I, Lecture 3

Yasushi Kondo

## y = salary, annual salary in thousands of dollars

x = roe, the average ROE for the prev. 3 years in %
y = salarydol, salary in dollars = 1000 salary
(2.26) & (2.40)
0, 1

1000

0 , 1000 1

(2.26) & (2.41)
0, 1

0 , 100 1

## Fn. form; What does linear mean?

Linear in parameters

Chapter 3
Multiple Regression Analysis: Estimation
Primary drawback of simple regression analysis

## Two or more independent variables

Explicitly control for many factors that simultaneously affect
the dependent variable
Build better models for prediction
Incorporate fairly general functional forms

## 3.1. Motivation for Multiple Regression

Example: Wage equation

SLR.4: E
=0
The key assumption SLR.4 often fails.
Omitted variables (other factors included in the error term, u)
are likely correlated with x.
Difficult to draw ceteris paribus conclusions.

## 3.1. Motivation for Multiple Regression

Example: Consumption fn. general fn. form

,
, unobserved factors in u
Primary interest = effect of
on

w.r.t.
,
holding
fixed.

income

+2

if

=0

,
=E
=0
E

,
= 0.
should be E

2016/4/11

## 3.2 Mechanics and Interpretation of

Ordinary Least Squares

MLR (3.6)

1 1

+ +

2 2

log

log

Fitted values

| 1,

2, ,

0, 1, ,

to get OLSE

=1
CEO tenure

Minimize (3.12)

Residuals

=0

=
=

+ +

= 1, ,

= 1, ,

## 3.2 Mechanics and Interpretation of

Ordinary Least Squares

## An OLS slope estimate measures the partial effect,

holding all other variables fixed.

=0

(3.16)
(3.17)

=
=

=0

(3.18)

+
1

+ 2 2 + +

1 + 2 2 + +
1 1

=1
1
=1

if

==

=0

1 1

=0

## We controlled for the variables , , ,

when estimating the effect of
on .

=1
9

10

## The Meaning of Holding Other Factors

Fixed in Multiple Regression

Eq. (3.19)

log

= 0.284 + 0.092

+ 0.0041

+ 0.022

## educ = the years of education

exper = the years of labor market experience
tenure = the years with the current employer
Ceteris paribus interpretation:
Another year of education increases wage by 9.2%, when
exper and tenure are fixed.

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## No data collection with holding other factors fixed

Data by random sampling are available

## Experimental data collected with holding other factors

fixed Apply Simple Regression

## Non-experimental data Apply Multiple Regression

to get ceteris paribus interpretation, or
to mimic Simple Regression with experimental data

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2016/4/11

(3.22)
1

## Sample average of residuals = 0

Avg. of = Avg. of
The point of averages , , , ,
regression line (hyper-plane)

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MLR

1 1

SLR

1 1

2 2

and

= 80.12 + 5.52

1 1

2 1

corr

1

if

= 0 or

=0

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## SST = SSE + SSR

R-squared = SSE/SST
R-squared = {corr(y, y-hat)}2

= 83.08 + 5.86
,
= 0.12

Homework assignment
SST = =1
SSE = =1
SSR = =1

2
2

## R-squared never decreases when any variable (even

irrelevant one) is added to a regression

## Perform a statistical test to check if partial effects are

zeros, to decide whether explanatory variables should be
added; do not use R-squared for this purpose.
Use adjusted R-squared, to compare goodness-of-fit of
regression models that have different numbers of s.
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## Age of the plan

Match rate: The rate of firms contribution
to insurance premium paid by worker

## MLR (5.52) and SLR (5.86) give similar results because

and
are little correlated, although age is
relevant.

## Problems 3, 9 and 11 in Chapter 2 (repeated)

Computer exercises C2, C3 and C5 of Chapter 3

+ 0.243

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Goodness-of-fit

on

## Eq. (3.23): Relationship between OLSEs by MLR and SLR

1

2, ,

Part of
that is uncorrelated with the other s
after the effects of the other s are partialled out, or
netted out.

on

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## Comparison of SLR and MLR estimates

Residual,

=1

1 : residual by reg.

## Sample covariance between s and residuals = 0

21

1
=1

Sum of residuals = 0

## Would be explained in the TA session this week.

Part (iv) of C3 is advanced because it is related to the topics
that will be covered in the next lecture.

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