a) 4 conditions of regression

I- VARIABLES ARE NORMALLY DISTRIBUTED Regression assumes that variables have normal distributions II- ASSUMPTION OF A LINEAR RELATIONSHIP BETWEEN THE INDEPENDENT AND DEPENDENT VARIABLE(S).

Standard multiple regression can only accurately estimate the relationship between dependent and independent variables if the relationships are linear in nature

III- VARIABLES ARE MEASURED WITHOUT ERROR (RELIABLY)

The nature of our educational and social science research means that many variables we are interested in are also difficult to measure, making measurement error a particular concern. In simple correlation and regression, unreliable measurement causes relationships to be underestimated increasing the risk of Type II errors

iV- ASSUMPTION OF HOMOSCEDASTICITY

Homoscedasticity means that the variance of errors is the same across all levels of the IV. When the variance of errors differs at different values of the IV, heteroscedasticity is indicated

B- 2 ways of HOMOSCEDASTICITY

1- Use Weighted Least Squares. A more difficult option (but superior when you can

make it work right) is the use of weighted least squares. Generalized Least Squares [GLS] is a technique that will always yield estimators that are BLUE when either heteroscedasticity or serial correlation are present. OLS selects coefficients that minimize the sum ofsquared regression residuals, i.e.

2- Respecify the Model/Transform the Variables. As noted before, sometimes heteroscedasticity results from improper model specification. There may be subgroup differences. Effects of variables may not be linear. Perhaps some important variables have been left out ofthe model. If these are problems deal with them first!!! Dont just launch into other techniques, such as WLS, because they dont get to the heart of the problem.

e) Durbon Watson Test A number that tests for autocorrelation in the residuals from a statistical regression analysis. The Durbin-Watson statistic is always between 0 and 4. A value of 2 means that there is no autocorrelation in the sample. Values approaching 0 indicate positive autocorrelation and values toward 4 indicate negative autocorrelation. Autocorrelation can be a significant problem in analyzing historical pricing information if one does not know to look out for it. For instance, since stock prices tend not to change too radically from one day to another, the prices from one day to the next could potentailly be highly correlated, even though there is little useful information in this observation. In order to avoid autocorrelation issues, the easiest solution in finance is to simply convert a series of historical prices into a series of percentage-price changes from day to day.

f) Transformation of D.V In order to make the variable better fit the assumptions underlying regression, we need to transform it. There are a number of ways to do this, but the most common for our purposes is to take the log of Giving. (This is easily done in Data Desk using a derived variable and the log statement; just remember to take the log of Giving plus a nominal value of 1, because you cant take a log of zero.) When we call up a histogram of Log of Lifetime Giving, we can see that the distribution is significantly closer to the normal probability distribution. Its a bit skewed to one side, but its a big improvement http://cooldata.wordpress.com/2010/03/04/why-transform-thedependent-variable/

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