QUESTION:

The following estimated equations is about major league baseball salaries. The dependent

variable is Isalary and it is a log of salary. The two explanatory variables in the major league

(years) and runs batted in per year (rbisyr):

1. ̂ = 12.373 + 0.1770 𝑦𝑒𝑎𝑟𝑠

𝐼𝑠𝑎𝑙𝑎𝑟𝑦

(0.098) + (0.0132)

𝑛 = 353 𝑆𝑆𝑅 = 326.196 𝑆𝑆𝐸 = 0.964 𝑅 2 = 0.337

2. ̂ = 11.861 + 0.0904𝑦𝑒𝑎𝑟𝑠 + 0.0302𝑟𝑏𝑖𝑠𝑦𝑟

𝐼𝑠𝑎𝑙𝑎𝑟𝑦

(0.084) (0.0118) (0.0020)

𝑛 = 353 𝑆𝑆𝑅 = 198.475 𝑆𝑆𝐸 = 0.753 𝑅 2 = 0.597

a. How many degrees of freedom are in each regression?

b. Why is the SSE smaller in the second regression than the first?

c. The sample correlation coefficient between years and rbisyr is about 0.487. Does this

make sense

d. What is the variance of inflation for the slop coefficient in the multiple regression?

Will you say there is little, moderate or strong collinearity between years and rbisyr

e. How come the standard error for the coefficient of years in the multiple regression is

lower ta its counterpart in the simple regression.

SOLUTION:

a. 𝐷𝑒𝑔𝑟𝑒𝑒 𝑜𝑓 𝑓𝑟𝑒𝑒𝑑𝑜𝑚 (𝑑𝑓) = 𝑛 − 𝑘 − 1

For the first regression

𝐷𝑓 = 𝑛 − 𝑘 − 1

𝑛 = 353 , 𝑘=1

= 353 − 1 − 1 = 351

For the second regression

𝐷𝑓 = 𝑛 − 𝑘 − 1

𝑛 = 353 , 𝑘=2

= 353 − 2 − 1 = 351

b. The first regression is that of a simple regression whereas the second is a multiple

regression with two regressors. For any two models (a simple regression model and a

multiple regression model), if the value of 𝛽1 = 0 then SSE will be identical in both a

simple regression model and a multiple regression model. However, as more explanatory

variables are added to the model, the SSE decreases. For the above models, one more

explanatory variable is included in the second regression thus SSE in the second regression

is smaller. The SSR falls from 326.196 to198.475 when another explanatory variable is

added, and the degrees of freedom also falls by one, which also affects the standard error

c. The range of values for the correlation coefficient is between -1.0 to 1.0. A correlation

coefficient of 0.487 implies a positive correlation between the major league (years) and

runs batted in per year (rbisyr). This means that the more years spent in the major league,

the higher the number of runs batted in per year.

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d. 𝑉𝑎𝑟𝑎𝑖𝑛𝑐𝑒 𝑜𝑓 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 = 1−𝑅 2

The slope is the years, thus

1
𝑉𝐼𝐹𝑦𝑒𝑎𝑟𝑠 = 2
𝑅𝑦𝑒𝑎𝑟𝑠

1
= 1−0.597

= 2.48139

The variance of the slope coefficient (the number of years) is inflated by the factor of

2.48139. By the rule of thumb if the variance of inflation factor is between 1 and 5 it is

moderately correlated. From this value, we can say there is a moderate collinearity between

number of years in the major league and the runs batted in per year.

e. In the multiple regression, the coefficient of years is lower because one more explanatory

variable (runs batted in per years) is introduced.