15.

034 Data Analysis For Managers

Doyle/Rigobon/Stoker

Problem SET #2 Solutions

The main goal of this problem set is to provide a deeper understanding of what regression
estimation does using a simple context of one variable regressed on another.
1. Application: Regression Using Human Resources Data
Please see the attached .do and .log file for the answers.
What to take away:
You need to be able to interpret a regression coefficient.
Here: the coefficient on experience is 9093.87; this means that a 1 unit increase in
experiencein this case 1 yearis associated with a $9093.87 increase in salary.
You need to know what a predicted value is:
For Model:
The predicted value for person i:
where the hat represents an estimate
The residual for person i: how the predicted is different from the actual value:

The regression line is the predicted y for each x; the scatter plot shows the actual value.
Heres an example in a different context:

Source: http://shazam.econ.ubc.ca/intro/ols.htm)
1

2. For this problem we will use PS2.dta.

Takeaways:
The OLS formula is Cov(Y1,X)/V(X) so you need to know something
about covariance
Note that the correlation, which you should be familiar with is just a
,
\
different re-scaling of covariance =

It aims to estimate a linear relationship, so even if there is a clear nonlinear relationship, a linear regression will miss it.
Compare

and

: They are similar.

How does the greater noise in the relationship between Y2 and X show
up in your regression output?
The estimate is shown to be less precisely estimated: it has a much
larger standard error.
Note, the OLS coefficient on x in a model of y2 shows a much
smaller relationship: 0.25 is the coefficient, even though there is a
very strong (nonlinear) relationship between the two variables.
Not required here: You could regress y on x and x-squared.
The correlation between X is zero by assumption and the
computer makes it so. This does not mean that the correlation
between X and the true error in the model, , is zero.