IIM LUCKNOW

ECONOMETRICS
ASSIGNMENT - I

7/30/2011

Submitted by: Group 13

Abhishek Mishra FPM11007

Issac K Varghese FPM11004

Shivam Singh

Tanvi Goila

FPM11011

Parvathi Ganesh FPM11012

FPM11006

Assignment 1 of Econometrics. Submitted to Prof Sukumar Nandi, towards partial completion of the
course Econometrics, Term 4.

Contents
Introduction .................................................................................................................................................. 3
Model 1 ......................................................................................................................................................... 4
Goodness of fit .......................................................................................................................................... 5
Multicollinearity ........................................................................................................................................ 5
Test for Heteroskedasticity ....................................................................................................................... 8
Autocorrelation ....................................................................................................................................... 10
Model 2 ....................................................................................................................................................... 11
Goodness of fit ........................................................................................................................................ 12
Multicollinearity ...................................................................................................................................... 12
Test for Heteroskedasticity ..................................................................................................................... 14
Autocorrelation ....................................................................................................................................... 16
Conclusion and comparison of both models .............................................................................................. 16

Introduction
International liquidity is considered as that stock of asset which is available to a countrys monetary
authorities to cover payments imbalances or to influence the exchange value of the currency of the
country. The standard level of international reserve that provides the international liquidity consists of
the following four elements:

Gold

Short term foreign exchange holding in convertible currencies

Special drawing rights (SDR)

Reserve position in International Monetary Fund

Thus we find that the level of reserve can be considered as a stock of reserve which represents the
purchasing power of the country as a whole and it remains at the disposal of the monetary authorities
which can be used to moderate the domestic economic impact of the decline of foreign exchange
receipt.
To test the theories regarding international reserve (IR), we form two models. The first model suggests
that IR depends on the gross domestic product (GDP), ratio of imports to GDP, and the ratio of exports
to imports. The model is a log linear one.
The second model suggests that IR depends on the GDP, ratio of domestic price level to foreign price
level, and the ratio of domestic interest rate to foreign interest rate. We develop linear regression
equations for both models and use various tests to examine the coefficients of the independent
variables, the fit of the models, and the assumptions of the classical normal linear regression model.

Model 1
The model 1 equation is
Ln R = b0 + b1 Ln GDP + b2 Ln (M/Y) + b3 Ln (X/M) + u
Where

R is the international reserve of a country

GDP is the gross domestic product

M / Y is the ratio of imports to GDP

X / M is the ratio of exports to imports

The data was taken for Germany from the years 1980 to 2010. GDP is taken in the national currency,
exports and imports are taken keeping the values of 2000 as index number 100.
International reserve is further taken as the sum of

Total reserves minus gold

The amount of special drawing reserves (SDR) of the country

The national value of gold

The deposit money in banks

International reserves are expressed in Millions of US dollars.

The regression was done by the ordinary least squares method and the output shown was as follows:
Dependent Variable: LOG(RES)
Method: Least Squares
Date: 07/30/11 Time: 10:39
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
LOG (RES) = C(1) + C(2)*LOG( G) + C(3)* LOG(I/G) + C(4)
*LOG(E/I)

C(1)
C(2)
C(3)
C(4)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

2.503570
1.561202
0.372604
0.548882

0.691067
0.134613
0.152069
0.459569

3.622759
11.59771
2.450224
1.194342

0.0011
0.0000
0.0208
0.2424

0.907363
0.897438
0.282231
2.230320
-2.788580

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

13.11562
0.881274
0.424286
0.607503
2.116491

The regression model accordingly is:

LOG (RES) = -4.404185751 + 1.561201*LOG( G) + 0.3726041* LOG(I/G) + 0.5488818*LOG(E/I)

t-statistics

3.622

11.597

2.45

1.194

P-value

0.0011

0.0000

0.0208

0.2424

Goodness of fit
The R2 given by the model is 0.907363, and the adjusted R2 is 0.897438. This suggests that the model
fits very well by the given independent variables, as more than 99% of the model is explained by
regression, and less than 1% by the error term.

Multicollinearity
Multicollinearity is defined as the presence of linear relationships between the explanatory variables.
Perfect multicollinearity makes the coefficients of the variables indeterminate and the standard error

infinite. If it is less than perfect, the coefficients are determinate but possess large standard errors. This
causes the t values to become insignificant. In the above model, the t values are all significant; we can
assume there is no multicollinearity. This is further verified by the R2 values when an independent
variable is regressed against the other independent variables.
Ln GDP on others: R2 value of 0.3759
Ln M/Y on others: R2 value of 0.2903
Ln X/M on others: R2 value of 0.4799
By Kliens rule of thumb as the R2 value from none of the regressions is larger than the overall R2, the
hypothesis of multicollinearity can be rejected. We can also infer that though the individual R2 values are
high, the variances are not inflated. The regression models of the independent variables are shown:
Dependent Variable: LOG(G)
Method: Least Squares
Date: 07/30/11 Time: 12:24
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
LOG( G) = C(1) + C(2)* LOG(I/G) + C(3) *LOG(E/I)

C(1)
C(2)
C(3)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

7.105454
-0.159691
-4.410009

0.953323
0.333797
1.162649

7.453352
-0.478408
-3.793071

0.0000
0.6359
0.0007

0.375978
0.332942
0.467872
6.348235
-19.52509

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

7.419778
0.572856
1.407818
1.545231
0.248646

Dependent Variable: LOG(I/G)

Method: Least Squares
Date: 07/30/11 Time: 13:52
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
LOG(I/G) = C(1) + C(2)* LOG( G) + C(3) *LOG(E/I)

C(1)
C(2)
C(3)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

-2.402861
-0.038142
1.713258

0.607396
0.082609
0.491713

-3.956003
-0.461711
3.484267

0.0005
0.6477
0.0016

0.290309
0.241365
0.228658
1.516252
3.385877

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

-2.643949
0.262525
-0.024117
0.113295
0.293217

Dependent Variable: LOG(E/I)

Method: Least Squares
Date: 07/30/11 Time: 13:54
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
LOG(E/I) = C(1) + C(2)* LOG(I/G) + C(3) * LOG( G)

C(1)
C(2)
C(3)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

0.746402
0.100190
-0.061597

0.125046
0.040554
0.015003

5.969031
2.470531
-4.105668

0.0000
0.0196
0.0003

0.479925
0.444058
0.055295
0.088670
48.81114

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

0.024465
0.074161
-2.863196
-2.725783
0.813217

Test for Heteroskedasticity

The assumption of homoskedasticity implies that conditional on the explanatory variables, the variance
of the unobserved error, u, was constant. If this is not true, that is if the variance of u is different for
different values of the xs, then the errors are heteroskedastic. In such a case, the variances of the
coefficients are not least. We test for this using the whites test.
Null Hypothesis: H0: There is Heteroskedasticity in the chosen sample
The test was done without using cross terms of the independent variables. Regression equation formed
was

resid^2 = c(1) + c(2)*g + c(3)*log(CPI/CPI_) + c(4) *log(R / Rf) + c(5)*(g)^2 + c(6)*(log(CPI / CPI_))^2 +
c(7)*(log(R/Rf))^2 + c(8)*g*log(CPI/CPI_) + c(9)*g*log(R / Rf) + c(10)*log(CPI / CPI_)*log(R/Rf)

Where resid^2 is the square of the residual term. The chi square in this case is estimated as
n.R2 ~ 2
The estimated chi square value is 23.78, and the probability associated at 20 degrees of freedom is
0.2965. We therefore reject the hypothesis at a significance level of 1%. The variance in error terms is
constant. This means that the standard errors as given by the OLS estimates above are accurate.

White Heteroskedasticity Test:

F-statistic
Obs*R-squared

1.228549
10.70341

Prob. F(9,22)
Prob. Chi-Square(9)

0.328022
0.296587

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 07/30/11 Time: 12:04
Sample: 1979 2010
Included observations: 32

Variable

Coefficien
t

Std. Error

t-Statistic

Prob.

C
G
G^2
G*I
G*E
I
I^2
I*E
E
E^2

1.168832
-0.014195
-3.46E-06
0.000816
-0.000556
-0.040830
-0.038303
0.064806
0.184553
-0.028973

7.407291
0.012426
6.77E-06
0.000706
0.000639
0.573666
0.027100
0.048674
0.491241
0.022018

0.157795
-1.142365
-0.512140
1.156235
-0.868662
-0.071173
-1.413431
1.331443
0.375687
-1.315894

0.8761
0.2656
0.6137
0.2600
0.3944
0.9439
0.1715
0.1967
0.7107
0.2018

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat

0.334482
0.062224
4.398633
425.6554
-86.81234
2.198781

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)

0.838109
4.542221
6.050771
6.508814
1.228549
0.328022

Autocorrelation
Autocorrelation is said to exist when there is correlation between the error terms. This usually is the
case in time series data. In the presence of autocorrelation OLS estimators do not have the least
variance. We test for autocorrelation using the Durbin Watson test.

The null hypothesis is that there is no positive or negative correlation between the error terms. The
Durbin Watson d statistic is estimated at 2.11 by the model. The value of dL and dU at 0.01 significance
level, for the 4 parameter equation, 32 observations are 0.988 and 1.418, respectively. As the value lies
between dU and 4 - dU we accept the null hypothesis of no autocorrelation.

Model 2
The model 2 equation is:
R = a0 + a1 GDP + a2 (CPI / CPI *) + a3 (Rd / Rf) + e
Where

R is the international reserve of a country

GDP is the gross domestic product
CPI / CPI* is the ratio of domestic price level to foreign price level
Rd / Rf is the ratio of domestic interest rate to foreign interest rate

The data was taken for Germany from the years 1980 to 2010. GDP is taken in the national currency,
exports and imports are taken keeping the values of 2000 as index number 100. Rd and Rf are the
interest rates per annum. GDP and international reserves are as taken in model 1.
The regression was done by the ordinary least squares method and the output shown was as follows:
Dependent Variable: RES
Method: Least Squares
Date: 07/30/11 Time: 14:06
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
RES = C(1) + C(2)*G + C(3)* ( CPI / CPI_ ) + C(4) * ( R / RF )

C(1)
C(2)
C(3)
C(4)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

-1169.869
0.661653
796.4500
-158.7667

993.1031
0.102499
810.4668
103.2305

-1.177994
6.455247
0.982705
-1.537983

0.2487
0.0000
0.3342
0.1353

0.817618
0.798077
255.6566
1830088.
-220.6723

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

699.4420
568.9368
14.04202
14.22523
1.423186

The regression equation thus formed is:

RES = -1169.869354 + 0.661653412*G + 796.4500315* (CPI / CPI_ ) - 158.7666966 * ( R / RF )
t-stats -1.177

6.455

0.982

-1.537

p-val

0000

0.3342

0.1353

0.2487

Goodness of fit
The R2 given by the equation is 0.817618, and the adjusted R2 is 0.798077. This suggests that the model
is explained up to 96.7 % by the regression, and the remaining 3.3% by the error term.

Multicollinearity
The regression models of variables on other explanatory variables are shown:
Dependent Variable: G
Method: Least Squares
Date: 07/30/11 Time: 14:32
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
G = C(1) + C(2)* ( CPI / CPI_ ) + C(3) * ( R / RF )

C(1)
C(2)
C(3)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

6862.515
-5852.200
772.1047

1959.909
1752.690
181.5503

3.501445
-3.338981
4.252841

0.0015
0.0023
0.0002

0.674676
0.652240
548.8463
8735734.
-245.6812

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

1920.008
930.7030
15.54257
15.67999
0.426192

Dependent Variable: CPI/CPI_

Method: Least Squares
Date: 07/30/11 Time: 14:33
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
( CPI / CPI_ ) = C(1) + C(2)* G + C(3) * ( R / RF )

C(1)
C(2)
C(3)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

1.138467
-5.81E-05
-0.000884

0.033210
1.12E-05
0.018348

34.28057
-5.186649
-0.048166

0.0000
0.0000
0.9619

0.514304
0.480807
0.054686
0.086725
49.16598

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

1.025704
0.075894
-2.885374
-2.747961
0.297968

Dependent Variable: R/RF

Method: Least Squares
Date: 07/30/11 Time: 14:34
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance
(R / RF)= C(1) + C(2)* ( CPI / CPI_ ) + C(3) * ( G)

C(1)
C(2)
C(3)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood

Coefficien
t

Std. Error

t-Statistic

Prob.

0.602436
-0.049309
0.000428

1.251863
1.022160
0.000130

0.481232
-0.048240
3.299232

0.6340
0.9619
0.0026

0.507105
0.473112
0.408485
4.838949
-15.18142

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Durbin-Watson stat

1.373025
0.562753
1.136339
1.273751
0.705281

GDP on others: R^2 value of 0.6746

CPI / CPI* on others: R^2 value of 0.5143
Rd / Rf on others: R^2 value of 0.5071
By Kliens rule of thumb as the R2 value from none of the regressions is larger than the overall R2, the
hypothesis of multicollinearity can be rejected. We can also infer that though the individual R2 values
are high, the variances are not inflated.

Test for Heteroskedasticity

Null Hypothesis: H0: There is Heteroskedasticity in the chosen sample

The test was done without using cross terms of the independent variables. Regression equation formed
was
resid^2 = c(1) + c(2)*log( g) + c(3)* log(i/g) + c(4) *log(e/i) + c(5)*(log(g))^2 + c(6)*(log(i/g))^2 +
c(7)*(log(e/i))^2 + c(8)*log(g)*log(i/g) + c(9)*log(g)*log(e/i) + c(10)*log(i/g)*log(e/i)

Where resid^2 is the square of the residual term. The chi square in this case is estimated as
n.R2 ~ 2

The estimated chi square value is 23.78, and the probability associated at 20 degrees of freedom is
0.1179. We therefore reject the hypothesis at a significance level of 1%. The variance in error terms is
constant. This means that the standard errors as given by the OLS estimates above are accurate.

White Heteroskedasticity Test:

F-statistic
Obs*R-squared

3.497118
27.65123

Prob. F(20,11)
Prob. Chi-Square(20)

0.018528
0.117916

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 07/30/11 Time: 14:09
Sample: 1979 2010
Included observations: 32
White Heteroskedasticity-Consistent Standard Errors & Covariance

Variable

Coefficien
t

Std. Error

t-Statistic

Prob.

C
G
G^2
G*CPI
G*CPI_
G*R
G*RF
CPI
CPI^2
CPI*CPI_
CPI*R
CPI*RF
CPI_
CPI_^2
CPI_*R
CPI_*RF
R
R^2
R*RF
RF
RF^2

824001.0
-1225.633
0.145811
120.9695
-118.0052
105.6628
-71.43082
-279154.8
8075.568
-15082.93
-8795.315
11802.46
245318.8
7307.481
-203.0753
-3821.211
946027.9
-17180.70
9302.578
-747286.8
403.8407

30892601
4220.531
0.105240
102.9656
66.16038
62.70799
42.94319
1079353.
12574.84
18000.31
12900.12
19318.21
649463.2
6650.290
8961.289
11263.52
666922.8
21244.03
9422.630
1220502.
12832.58

0.026673
-0.290398
1.385513
1.174853
-1.783623
1.684997
-1.663379
-0.258632
0.642200
-0.837926
-0.681801
0.610950
0.377725
1.098821
-0.022661
-0.339256
1.418497
-0.808731
0.987259
-0.612278
0.031470

0.9792
0.7769
0.1933
0.2649
0.1021
0.1201
0.1244
0.8007
0.5339
0.4199
0.5095
0.5536
0.7128
0.2953
0.9823
0.7408
0.1838
0.4358
0.3447
0.5528
0.9755

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat

0.864101
0.617011
105546.1
1.23E+11
-398.4615
2.976792

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)

57190.25
170549.1
26.21634
27.17823
3.497118
0.018528

Autocorrelation

The null hypothesis is that there is no positive or negative correlation between the error terms. This is
tested by the Durbin Watson test. The Durbin Watson d statistic is estimated at 1.423 by the model. The
value of dL and dU at 0.01 significance for the 4 parameter equation and 32 observations are 0.988 and
1.418 respectively. As the value lies between dU and 4 - dU we accept the null hypothesis of no
autocorrelation.

Conclusion and comparison of both models

We see from the tests done that the model 1 equation shows a better estimate of the International
reserves. This equation has a better goodness of fit (higher adjusted R2) and all the explanatory variables
are statistically significant. The presences of multicollinearity, autocorrelation and heteroskedasticity
have been rejected.
In contrast in model 2, CPI/CPI* and Rd/Rf, two of the explanatory variables are not statistically
significant.
Thus we use model 1 for estimation:
LOG (RES) = -4.404185751 + 1.561201744*LOG(G) + 0.3726041007* LOG(I/G) +
0.5488818994*LOG(E/I)
Positive coefficients show that there is positive correlation between the dependent and independent
variables. Thus, an increase or decrease in any of the three would cause a corresponding increase or
decrease in the IR.