Applied Econometrics

Chapter 3:
Simple
Regression
 Applied Econometrics
Simple Regression

1. Introduction to the Classical Linear Regression

Model
2. The OLS Method of Estimation
3. The Overall Goodness of Fit
4. Hypothesis Testing
5. How to Estimate a Simple Regression in EViews
6. Applications and Examples
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Learning Objectives

Compute the equation of a simple regression line

from sample of data, and interpret the slope and
intercept of the equation.
Full understanding of the simple OLS method of
estimation and discussion of properties of
estimated coefficients.
Computation of standard error of estimate and
interpretation of its meaning and use in Hypothesis
Testing.
Understanding and interpreting the R2
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Introduction of OLS

For specification of the best model lot of working is required

for appropriate decision that how many and whose variables
should be included in the model.
Regression analysis is the process of constructing a
mathematical model or function that can be used to predict
or determine one variable by another variable.
Key issue here is direction of causation of the two
variables, or which variable depends on the other.
Therefore we have two cases of variables:
dependent (usually denoted by Y)
independent /explanatory/regressor (usually
denoted by X)
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Reasons behind the Existence of Disturbance/Error
term/Residual: Residual (ut ) exists in the model due to
following reasons which may affect the results reliability.
Omission of Explanatory Variables: There might be other
factors (other than Xt) affecting Yt. This may be because we
dont know or we exclude them even we know because we
might be unable to measure them.
Aggregation of Variables: To avoid having too many
variables and therefore we attempt to summarize in aggregate
a number of relationships in only one variable.
Model Misspecification: we might have a misspecified
model in terms of its structure. E.g. it might be Yt is not
affected by Xt, but it is affected by its previous value (Xt-1)
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Cont.
Functional Misspecification: The relationship
between X and Y might be non-linear. It also
become the reason of error term.
Measurement Errors: If the measurement of one
or more variables is not correct then errors appear
in the relationship and these contributes to the
disturbance term.
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The Scatter Plot
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Four Ways of Fitting a Line in the Data

By eye
Connecting the first with the last observation
Take the average of the first two and the
average of the two last and connect
Apply Ordinary Least Squares
 Applied Econometrics
Derivation of Regression Models or OLS
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The Coefficient of Determination

The proportion of variability of the dependent

variable accounted for or explained by the
independent variable in a regression model.

R2 and takes values from 01.

10
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Hypothesis Testing
Testing individual coefficients (t-tests)
Testing for the overall significance (F-test)
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The Regression Line
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Regression in EViews (1) (1)

Step 1 Open EViews.

Step 2 Choose File/New/Workfile to create a new file.

Step 3 Choose Undated or Irregular and specify

number of observations (in this case 20). A new
window appears which automatically contains a
constant (c) and a residual (resid) series.
 Applied Econometrics
Regression in EViews (2)
Step 4 In the command line type:
genr x=0 (press enter)
genr y=0 (press enter)
which creates two new series named x and y that contain
zeros for every observation.
Open x and y as a group by selecting them and double
clicking with the mouse.
Step 5 Either type the data in EViews or copy/paste the
data from Excel. To edit the series press the edit +/
button. After editing the series press the edit +/ button
again to lock or secure the data.