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THEORETICAL CONSEQUENCES
Unbiasedness is the result of repeated
sampling.
Minimum variance does not mean small
numerical value.
Multicollinearity is a sample phenomenon.
PRACTICAL
CONSEQUENCES
Large variances and standard error of OLS
estimators
Wider confidence intervals
Insignificant t ratios
High R2 value but few significant t ratios
High sensitivity of estimators and standard
DETECTION OF
MULTICOLLINEARITY
High R2 but few significant t ratios
High pair wise correlations among explanatory
variables
Examination of partial correlations
Subsidiary or auxiliary regressions
The Variance Inflation Factor (VIF)
IS MULTICOLLINEARITY
NECESSARILY BAD?
Answer depends on the purpose of the study Collinearity is not a problem if the purpose is to
forecast future mean or estimate group of
coefficient
Collinearity is problem if the purpose is reliable
estimation of parameters.
REMEDIAL MEASURES
Drooping a variable(s) from the model
Acquiring additional data or a new sample
Rethinking the model
Prior information about some parameters
Transformation of variables
HETEROSCEDASTICITY:
WHAT HAPPENS IF THE ERROR
VARIANCE IS NONCONSTANT
HETEROSCEDASTICITY
The variance of error term or ui will
vary from
observation to observation.
The Nature of Heterorscedasticity:
The variance of dependent variable around
CONSEQUENCES OF
HETEROSCEDASTICITY
OLS estimators remain linear.
OLS estimators remain unbiased.
The estimators are not BLUE because they no
DETECTION OF
HETEROSCEDASTICITY
Nature of the problem
1. Prior studies
2. Use of cross-sectional data
their log.
3. Run regression of residuals against explanatory
variables or alternatively against the
dependent variable
In e2i = B1 + B2 In Xi + vi
4. If the null hypothesis that B2=0 is rejected
then heteroscedasticity exists
Glesjer Test
Using the absolute value of residuals
|ei|= B1 +B2Xi+ vi
Whites General Heteroscedasticity Test
1.
2.
3.
4.
AUTOCORRELATION: WHAT
HAPPENS IF ERROR TERMS ARE
CORRELATED
AUTOCORRELATION
Correlation between members of observation
s ordered in time(time-series data) or
space(cross-sectional data).
E(ui uj) 0
ij
Reasons of Autocorrelation
Inertia
The Cobweb Phenomenon
Model Specification Error
Data Manipulation
CONSEQUENCES OF
AUTOCORRELATION
OLS estimators are still linear and biased.
The estimators are not BLUE because they
reliable.
The
measure of true R2
The
computed
variances
and
standard
DETECTING AUTOCORRELATION
Graphical Method: Plotting residuals
against time.
The Durbin-Watson d test:
The ratio of the sum of squared differences
on successive residuals to RSS
d= (et et-1)2/et2
Underlying Assumptions
1. An intercept
2. The X variables are non-stochastic
3. The disturbances are generated by the
following mechanism:
ut= put-1 + vt
-1 p 1
lower limit dL
residuals et
2. Compute d
3. Find out the critical dL and du for given
sample size and the given number of
explanatory variables
Null Hypothesis Decision If
4. Decision rules:
No positive
reject
0<d<dL
correlation
No positive
No
dL d du
correlation
decision
No negative
reject
4-dL<d<4
correlation
No negative
No
4-dud4-dL
correlation
decision
REMEDIAL MEASURES
Transformation of model
Transformation process:
Two variable regression model
Yt=B1+B2Xt+ut
..(i)
Yt-1=B1+B2Xt-1+ut-1 ..(ii)
+ B2(Xt- p Xt-1)+vt
HOW TO ESTIMATE P
p=1: The first difference Method
P estimated from d statistic
p 1-d/2
Thank you