Introduction

to Econometrics (3rd Updated Edition)

by


James H. Stock and Mark W. Watson





Solutions to Odd-Numbered End-of-Chapter Exercises:
Chapter 6


(This version August 17, 2014)

2015 Pearson Education, Inc.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 6 1
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6.1. By equation (6.15) in the text, we know

n 1
R2 = 1 (1 R 2 ).
n k 1

Thus, that values of R 2 are 0.162, 0.180, and 0.181 for columns (1)(3).

2015 Pearson Education, Inc.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 6 2
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6.3. (a) On average, a worker earns $0.51/hour more for each year he ages.

(b) Sallys earnings prediction is 1.87 + 8.32 1 3.81 1+ 0.51 29 = 21.17 dollars
per hour.

Betsys earnings prediction is 1.87 + 8.32 1 3.81 1+ 0.51 34 = 23.72 dollars

per hour. The difference is $2.55/hour.

2015 Pearson Education, Inc.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 6 3
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6.5. (a) $23,400 (recall that Price is measured in $1000s).

(b) In this case BDR = 1 and Hsize = 100. The resulting expected change in price is
23.4 + 0.156 100 = 39.0 thousand dollars or $39,000.

(c) The loss is $48,800.

(d) From the text R 2 = 1 n n k11 (1 R 2 ), so R 2 = 1 n n k11 (1 R 2 ), thus, R2 = 0.727.

2015 Pearson Education, Inc.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 6 4
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6.7. (a) The proposed research in assessing the presence of gender bias in setting wages is
too limited. There might be some potentially important determinants of salaries:
type of engineer, amount of work experience of the employee, and education
level. The gender with the lower wages could reflect the type of engineer among
the gender, the amount of work experience of the employee, or the education level
of the employee. The research plan could be improved with the collection of
additional data as indicated and an appropriate statistical technique for analyzing
the data would be a multiple regression in which the dependent variable is wages
and the independent variables would include a dummy variable for gender,
dummy variables for type of engineer, work experience (time units), and
education level (highest grade level completed). The potential importance of the
suggested omitted variables makes a difference in means test inappropriate for
assessing the presence of gender bias in setting wages.

(b) The description suggests that the research goes a long way towards controlling
for potential omitted variable bias. Yet, there still may be problems. Omitted
from the analysis are characteristics associated with behavior that led to
incarceration (excessive drug or alcohol use, gang activity, and so forth), that
might be correlated with future earnings. Ideally, data on these variables should
be included in the analysis as additional control variables.

2015 Pearson Education, Inc.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 6 5
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6.9. For omitted variable bias to occur, two conditions must be true: X1 (the included
regressor) is correlated with the omitted variable, and the omitted variable is a
determinant of the dependent variable. Since X1 and X2 are uncorrelated, the
estimator of 1 does not suffer from omitted variable bias.

2015 Pearson Education, Inc.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 6 6
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6.11. (a) (Y b X
i 1 1i b2 X 2i )2

(b)

(Yi b1 X 1i b2 X 2i ) 2
= 2 X 1i (Yi b1 X 1i b2 X 2i )
b1
(Yi b1 X 1i b2 X 2i ) 2
= 2 X 2i (Yi b1 X 1i b2 X 2i )
b2

X 1iYi 2 X 1i X 2i
(c) From (b), 1 satisfies X 1i (Yi 1 X 1i 1 X 2i ) = 0 , or 1 =
X 12i

and the result follows immediately.

X 2iYi 1 X 1i X 2i
(d) Following analysis as in (c) 2 = and substituting this into the
X 22i

X 1iY 2 i i X1
X Y X 1i X 2 i
X 1i X 2i
expression for 1 in (c) yields 1 = 2i 2

.
X 12i

X 22i X 1iYi X 1i X 2i X 2iYi

Solving for 1 yields: 1 =
X 12i X 22i ( X 1i X 2i ) 2

(continued on the next page)

2015 Pearson Education, Inc.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 6 7
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6.11 (continued)

(e) The least squares objective function is (Y b

i 0 b1 X1i b2 X 2i )2 and the partial
derivative with respect to b0 is

(Yi b0 b1 X 1i b2 X 2i )2
= 2 (Yi b0 b1 X 1i b2 X 2i ).
b0

Setting this to zero and solving for 0 yields: 0 = Y 1 X1 2 X 2 .

(f) Substituting 0 = Y 1 X1 2 X 2 . into the least squares objective function yields

(Y b1 X 1i b2 X 2i ) 2 = ( (Yi Y ) b1 ( X 1i X 1 ) b2 ( X 2i X 2 ) ) , which is
2
i 0

identical to the least squares objective function in part (a), except that all variables
have been replaced with deviations from sample means. The result then follows as in
(c).

Notice that the estimator for 1 is identical to the OLS estimator from the regression
of Y onto X1, omitting X2. Said differently, when (X 1i X1 )( X 2i X 2 ) = 0 , the
estimated coefficient on X1 in the OLS regression of Y onto both X1 and X2 is the same
as estimated coefficient in the OLS regression of Y onto X1.

2015 Pearson Education, Inc.