Advanced Econometrics

Assignment 1

Due Date: October 3, 2017, 11.59 pm

Kanika Mahajan
Ashoka University

Each question below carries 20 marks. The datasets are available at

http://fmwww.bc.edu/ec-p/data/wooldridge/datasets.list.html. Click on the
dataset to get the description of variables.

Question 1
Use the data given in wage1.dta le.
Consider the below specication:

wage = b0 + b1 educ + b2 exper + b3 expersq + b4 f emale + b5 married + u

a) (5 marks) Write down a model that allows the variance of u to dier between males and
females. The variance should not depend on other factors.

V ar(u|educ, exper, f emale, married) = var(u|f emale) = c0 + c1 f emale

Var for men is c0 and for women is c0 + c1

b) (5 marks) Estimate the above model using OLS estimation. Is the estimated variance of
the error term u higher or lower for females in this model.
Regress the estimated residual squares on indicator variable for women. The coecient of
female is negative. So, variance is lower for females.
c) (2 marks) Is the error term heteroscedastic in the above model? Discuss using an appro-
priate statistical test.
Whites's/B-P test for heteroscedasticity
d) (3 marks) Re-estimate the standard errors in the above model to make them robust to
heteroscedasticity. Comment on the change in results from part b).
No dierence in conclsions drawn
e) (5 marks) Suppose the variance of the error term is a function of only education and
gender. Re-estimate the model using the Weighted Least Square Estimation. Any change in
conclusion from estimation in part b)

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No change in conclusions

Question 2
Use the data mlb1.dta. This data gives salary gures and other characetristics of baseball
players in a particular year (more details at http://fmwww.bc.edu/ec-p/data/wooldridge/mlb1.des).
As a researcher you are interested in factors like experience (years, gamesyr), performance(bavg,
hrunsyr,rbisyr,allstar) and race(black, hispanic) which have an impact on the salary received
by baseball players. Consider the below specication.
lsalary =b0 + b1 years + b2 gamesyr + b3 bavg + b4 hrunsyr + b5 rbisyr + b6 allstar+
b7 black + b8 hispan

a) (3 marks) Estimate the above specication using OLS. Is race a signicant predictor of
salary? What can you say about the eect of performance on salary?
Race is not a signicant predictor. Only percentage years as all star matter. The other
variable like runs, rbis, bavg do not matter
b) (5 marks) Do you think there is a problem of high correlation among variables in the
above specication? Show with relevant statistics or tests.
VIF is high for rbisyr
c) (9 marks) How can you overcome the above problem? Discuss two methods.
Re-estimate alternative specications for both the methods. Give relevant justications for
these alternate specications.
First method: Drop rbisyr
Second Method: Do a PCA, get the rst principal component and use it as a control
Another: If they manually club variables after standardization (not the best method)
d) (3 marks) What can you say about the eect of performance on salary now in the above
specications in part c)?
First: runs scored have a signicant eect on salary now Second: Overall performance has
a signicantly positive eect on salary earned

Question 3
Use the data given in volat.dta le. Variable rsp500 is the monthly return on the Standard
and Poors 500 stock market index, at an annual rate. This includes price changes as well as
dividends. Variable i3 is the return on three month Treasury-bills, and pcip is the percentage
change in industrial production; these are also at an annual rate.
a) (3 marks) Plot the line graph for rsp500. Describe.
Answer stata
Consider the below specication

rsp500t = b0 + b1 pcipt + b2 i3t + ut

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b) (3 marks) Estimate the above model using OLS. Test for presence of AR(1) serial corre-
lation in the residuals of the above model.
Yes AR(1) serial correlated residuals
c) (5 marks) Obtain the residuals from the above model. Regress the estmated residuals on
their lag (1).

ut = ρut−1 + et

Do the residuals exhibit a very high degree of AR(1) serial correlation? Discuss.
ρ=0.24, Signicant rho yes but in terms of magnitude not very large
d) (3 marks) Are the obtained errors from the model in part c) i.e. et serially correlated?
Should they be theoretically serially correlated if AR(1) is the true model for serial correlation
in residuals of part b)?
Yes et are serially correlated
e) (3 marks) Can you estimate a structure on the residuals obtained from part b) such that
the errors et are not serially correlated?
AR(2) structure on residuals
f) (3 marks) Suggest a way to correct for serial correlation in residuals in part b) and show
the revised estimates of the specication using it.
Estimate using OLS and correct SE's (HAC)
PraisWinsten method: It only corrects for AR(1) but here that may not be relevant. Also, ρ
not large.